Part D: Factors which might have contributed to the rapid depreciation of the rand
Index
Page
Factors which in general affect an exchange rate
1
Determinants of the rand exchange rate
5
(1)
Long term: inflation differentials
7
(2)
Short and medium term:
(a) Macro-economic
11
factors
(3)
(b) Perceptions/sentiment
31
Short term:
36
(a) The role of the Reserve Bank
36
-
Exchange rate management
36
-
The Reserve Bank
40
-
Reserve Bank Policies
41
-
Inflation targeting
43
-
NOFP
48
-
The meeting of 14 October 2001 and the circulars
55
that followed
-
the issue of Circular D346 on 13 November 2001
(b) Speculation
76
77
-
Introduction
77
-
Authorised dealers
88
-
Non-residents
88
-
Importers and exporters (leads and lags)
89
The experts’ conclusions
98
Table of graphs, charts, diagrams and tables contained in Part D
Title
Page
Determinants of the exchange rate
6
A fundamental reason for long-term rand weakness:
SA inflation>foreign inflation
8
Exchange rate rand / US dollar
9
USD’s strength against other currencies in the rand’s “basket”
10
Rand trade weighted index
11
US: BBoP & Current Account
20
Euroland: BBoP & Current Account
21
Euroland: BBoP & TWI
22
Japan: BBoP & Current Account
23
Japan: BBoP & TWI
24
Mexico: BBoP & Current Account
25
Mexico: BBoP & TWI
26
China: NBoP & Current Account
27
China: NBoP & TWI
28
South Africa: Adjusted BBoP & Current Account
29
South Africa: Adjusted BBoP & TWI
30
SA rand per US dollar: graph 4A
33
SA rand per US dollar: graph 4B
33
Table of graphs, charts, diagrams and tables contained in Part D (continued)
Title
Page
CPIX inflation
45
The net oversold open forward position of the SARB since 1994
49
The correlation between the reduction of the NOFP
and the decline in the value of the rand
51
The relationship between the trade weighted ZAR and the NOFP
51
Rand / dollar from July 2001
60
Forward points on the ZAR relative to the spot rate
93
Real effective exchange rate
96
Exchange rate rand / US dollar
97
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
D
Factors which might have contributed to the rapid depreciation of the
rand in 2001
[1]
Factors which in general affect an exchange rate
1
1.1
Exchange rates and inflation
Inflation is a general rise in prices or a particular fall in the value
of the currency in purchasing power terms. The internal
purchasing power of a currency and its external value, ie its
exchange rate, are broadly related and they tend to move over
time together. Historically South Africa has had a faster than
average inflation rate and the rand has had a declining trend
against, for example, the US dollar: those two observations are
consistent with the view that the internal purchasing power of a
currency is related to its external purchasing power.
1.2
Exchange rates and export prices
Generally, better prices for a country’s important exports tend to
strengthen its currency. This is particularly true of commodity
exporters such as Australia, Canada, New Zealand and South
Africa. The exchange rates of those countries over time have
tended to rise and fall with their major export prices. If the prices
go up, there is generally more export value; producers spend
1
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
more in foreign currency to buy the domestic currency, which
tends to push up the currency on a simple supply and demand
basis.
1.3
Exchange rates and interest rates
A currency with above average inflation and that tends to
depreciate will tend to have higher than average interest rates.
From a non-resident perspective, a higher interest rate
compensates roughly and over time for capital losses from
currency devaluation. Raising interest rates (in South Africa the
repo rate in the first instance) tends to support the domestic
currency by making it more attractive to hold and more expensive
to borrow or short.1
1.4
Exchange rates and portfolio shifts
1.4.1 Mr McCauley expounded the proposition, which he said
might not be the average view of economists, that if either
residents or non-residents decide that they want assets
denominated in a given currency, say the rand, then the
tendency will be for that wish to be granted by the rand
gaining in value or the underlying assets gaining in value
or both. A portfolio shift away from the rand can take
different forms – an outright sale of equities or bonds; a
1
§1.1 to 1.3 are based on the evidence of McCauley Record 45
2
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
forward sale of the rand to hedge a long position or to
establish a short position.2
1.4.2 Mr McCauley gave a sobering perspective on the
significance, or rather lack of significance, of South Africa
for foreign investors. Each country of the world enjoys a
share in the world’s portfolio of investments. The
allocation to South Africa in that portfolio is less than 1%,
probably as little as ¼%. By the time a foreign investor
decides what amount to invest in South Africa, it has
“really made all the important decisions already”.3
1.5
Leads and lags
Mr McCauley expressed the opinion that while it may not on the
face of it appear to be so, a type of portfolio shift occurs in the
financing of imports and exports (leads and lags): every month of
lead in payment and lag in receipts represents an outflow of a 1/12
of trade. The leads and lags phenomenon makes the distinction
between goods and financial services seem artificial in practice.4
1.6
Exchange rates and contagion
Contagion, as Mr McCauley pointed out, is a medical term and if
you are going to catch a bug from somebody you need to come
2
3
4
McCauley Record 45 - 46
McCauley Record 47
McCauley Record 48
3
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
into contact with the bug or someone having the bug. As the term
is used in financial markets, however, there need be no contact.
One must distinguish between contagion based on (1) trade links,
(2) similarity and (3) profit or loss of investors. The first is clearly
observable; the second reflects perceptions of investors; and the
third suggests that risk arises from the character of the issuer of
the financial instrument. Contagion through trade links arises
when country A and country B compete in world markets. A
depreciation of B’s currency can hurt A’s competitiveness. A loss
of competitiveness can slow exports and economic activity and so
lead to pressure for a depreciation in A. Contagion through
similarity occurs in at least three circumstances:- economic
circumstances: Country A’s currency devalues. Investors analyse
the economic reasons for the devaluation, identify country B with
similar problems, and take their investments out of country B.
Asset class: investors may reduce exposure to a whole “asset
class” such as emerging markets or a subclass such as EMEA
(East Europe, Middle East, Africa). Policy or regime: countries
with similar policies or financial regimes are treated similarly.
For example, the Argentinean crisis led to higher interest rates in
Hong Kong because both had a dollar currency board. Contagion
through profit or loss: profits or losses from one exchange rate
4
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
can permit (force) positioning in (withdrawal from) another
exchange rate. For example, in mid-1998, profits from short
positions in the Japanese Yen allowed larger short positions in
commodity exporters’ currencies like the Australian, Canadian
and New Zealand dollars and South African rand.5
[2]
Determinants of the rand exchange rate
2
The exchange rate of the rand is determined by millions of decisions
taken daily by
-
South African consumers, corporates, foreign exchange dealers,
institutional investors and various arms of Government;
-
foreign banks, foreign corporates, foreign institutional investors,
foreign governments, multi-lateral institutions (such as the
International Monetary Fund (“IMF”) and the World Bank) and
foreign individuals such as tourists and consumers of South African
products.6
5
6
McCauley Record 50 - 55
Mr R Gouws, Chief Economist, Rand Merchant Bank, Expert Bundle 113
5
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
3
3.1
A convenient framework in which to consider the various factors
that may have contributed to the depreciation of the rand in 2001
is to have regard to the determinants testified to by Mr Gouws
and reflected in this slide:
Slide 2 Expert Bundle 118
3.2
In this report, the order in which the determinants are dealt with
are:
(1)
Long term:
(2)
Short & medium
Inflation differentials
(a)
macro-economic factors;
(b)
perceptions/sentiment
6
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
(3)
Short term:
(a)
the role of the Reserve
Bank;
(b)
(1)
speculation
Long Term
Inflation differentials
4
4.1
A fundamental reason for the long-term decline of the rand was
that the South African inflation rate was higher than that of its
trading partners. The reason is that if the internal value of any one
currency falls faster than the internal value of another, the
external value of that currency would, over time, reflect that
difference. So, for example, if the rate of inflation in the United
States of America is 1% per annum and in South Africa 9% per
annum, the depreciation by 8% will maintain the real value of the
rand against the US dollar.7
7
Gouws Expert Bundle 115; Stals Expert Bundle 170; Dr A Jammine, Director and Chief
Economist, Econometrix (Pty) Ltd, Expert Bundle 301
7
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Diagram 10 Expert Bundle 122
4.2
The slide in the value of the rand, in this phase, began in 2000.
During 1999 the rand traded at about R6 to the US dollar, but by
the end of 2000 it was trading close to R8 to the dollar, a
depreciation of approximately 33%:
8
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Chart 22 Expert Bundle 371
EXCHANGE RATE RAND / US DOLLAR
14.0
RATE
12.0
10.0
Dollar hits R8
8.0
Rand appreciates
initially on De Beers deal
6.0
2000
Chart 22
2001
2002
The Commission did not investigate the decline in 2000. One thing
seems clear and that is that at least until September 2000 the decline
could at least partly be explained by the strength of the US dollar. The
strength of the dollar against the trade weighted index (TWI) is shown in
this diagram:
9
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Diagram 13 Expert Bundle 124
The TWI is based on weightings determined by the relevant importance
of the trade of various countries with South Africa. The percentage
weightings in the basket of currencies is shown below:
10
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Diagram 14 Expert Bundle 124
(2)
Short to medium term
(a)
Macro-economic factors
5.1
An imbalance between the total disposable income and total
5
spending of a country is reflected in the net flow of goods and
services into or out of the country. These cross-border movements
of goods and services, together with a net movement of
international capital to and from the country, influences the
demand and supply for foreign exchange in the domestic foreign
exchange market.8 In a market where the exchange rate should be
8
Mboweni Bundle SARB (07) 16
11
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
free to find its own level, the supply of and demand for foreign
exchange are the main factors deciding the eventual level of the
exchange rate. An excess supply of foreign exchange should
usually be associated with an appreciation in the exchange value
of the domestic currency. Conversely, a shortage of foreign
exchange can be expected to cause a depreciation of the exchange
rate of the domestic currency.9
5.2
Demand for, and supply of, the rand are influenced by the state of
the global economy. There was a rapid decline in the performance
of the international economy commencing in 2000 and continuing
in 2001, the upshot of which was a decline in hard currency
liquidity in the market, leading to a downward pressure on the
rand.10
5.3
The effect of the attacks on the World Trade Centre and the
Pentagon on 11 September 2001 was the crash in global equity
markets which ensued and, in the words of Jammine: “…
increased risk aversion towards emerging markets still further and the
rand was once again seen to be in the firing line of this sentiment.
Commodity prices plunged in expectation of a dramatic deterioration in
global economic growth prospects and this affected the rand
9
10
Mboweni Bundle SARB (07) 16
Dr I Abedian, Chief Economist, Standard Bank of South Africa, Expert Bundle 276. See, too,
for example, Stals, Expert Bundle 173
12
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
particularly hard and South Africa was seen as a predominantly
commodity based economy. … The rand’s depreciation from R8.52 at
the time of the terrorist attack to R9.03 at the end of the month, was
seen primarily as the function of South Africa’s categorisation as an
emerging market currency at a time when international investors were
bailing out of emerging markets.”11
5.4
The deterioration in the global economy and the events of
September 11, 2001 had a negative effect on the South African
economy, and hence on the rand, in two material respects: the
flow of capital to emerging markets reduced and after September
11 international fund managers withdrew funds from what they
regarded as vulnerable economies in what was described as a
“flight to a safe haven”.
5.5
In the first half of 2001, despite the global downturn, domestic
income grew and gross domestic expenditure was less than
national disposable income. Consequently, South Africa had a
surplus of exports over imports. At the same time there was an
inflow of capital into the economy. Given an ample supply of
foreign exchange during this period, the exchange rate of the rand
showed limited variation and by the end of June 2001 was
11
Jammine Expert Bundle 321; Mboweni Bundle SARB (7) 16-17
13
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
roughly at the same level as at the beginning of the year (R8 to
the US dollar).12
5.6
In the second half of 2001, domestic spending exceeded total
national disposable income: excess spending over income lifted
total spending to a level 1.1% higher than national disposable
income in the third quarter and 0.3% higher in the fourth quarter.
The excess of total domestic spending over total national disposal
of income was expressed in a deficit on the current account of the
balance of payments. This imbalance created a need in the forex
market for an inflow of international capital in order to limit
downward pressure on the exchange value of the rand. The deficit
on the current account of the balance of payments, however, was
not matched by any inflows of international capital into the
economy.13
5.7
When a deficit on the current account of the balance of payments
is not accompanied by an inflow of capital, the deficit is widely
perceived as a major source of exchange rate instability. Where
the demand for foreign exchange exceeds the supply of foreign
12
13
Mboweni, Bundle SARB (07) 17
Mboweni, Bundle SARB (07) 17, 20
14
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
exchange, a depreciation in the exchange rate of the rand could be
expected as a normal market reaction.14
5.8
The following accounts are worthy of detailed analysis:The services account in the current account of the balance of
payments.15
5.8.1 The shortfall on South Africa’s services account with the
rest of the world widened considerably from the first to the
second quarter of 2001. This higher deficit was related to
inward movements of foreign direct equity investment
giving rise to dividend payments on non-resident
shareholdings. Investment income received from offshore
equity investments made by South African companies also
increased, but to a smaller extent that the increase in
dividend payments. The overall deficit on the services and
income account widened from a seasonally adjusted and
annualised value as follows:
14
15
First quarter
R37.2 billion
Second quarter
R47.1 billion
Third quarter
R48.6 billion
Mboweni Bundle SARB (07) 17; Stals Expert Bundle 173-174.
The balance on the current account of the balance of payments is the sum of exports and imports of goods and
services out of and into South Africa. The current account consists of two accounts: the trade account and the
services account. The services account records income payments and receipts, such as dividends, interest and
employee compensation, transportation fees for goods and passengers, travel services and other services.
15
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Fourth quarter
R41.7 billion16
5.8.2 The financial account of the balance of payments
The financial account summarises the international capital
flows and covers all transactions associated with changes
of ownership in the foreign assets and liabilities of an
economy. Three broad categories of investment are
distinguished:
-
direct investment;
-
portfolio investment; and
-
other investment.
5.8.3 The imbalance on the financial account of South Africa’s
accounts with the rest of the world changed from a surplus
(or an inflow of capital) of R4.7 billion in the third quarter
of 2001 to a deficit (or outflow of capital) of R1.5 billion
in the fourth quarter.
(1)
Direct investment
Foreign direct investment (“FDI”) flows into South Africa
are reflected in an increase in direct foreign liabilities.
Direct investment is that category of international
investment which reflects the objective of an investor in
one country to obtain a lasting interest in another country.
16
Mboweni Bundle SARB (7) 23
16
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Non-residents invested direct investment capital into the
South African economy during the first three quarters of
2001, but this changed to an outflow of R1.9 billion in the
fourth quarter. South African companies increased their
holdings of foreign direct investment assets by R5.4
billion during the fourth quarter of 2001, mainly by
acquiring a dominant interest in the equity capital of
foreign companies.
On a net basis, i.e. offsetting changes in direct foreign
assets against changes in direct foreign liabilities, FDI
changed from an inflow of R3.6 billion in the third quarter
of 2001 to an outflow of R7.3 billion in the fourth quarter,
thus contributing to the weakness of the rand.17
(2)
Portfolio investment
Portfolio investment includes investment in equity and
debt securities not classified as direct investment. Nonresident investors increased their holdings of domestic
equity securities by R7.9 billion during the fourth quarter
of 2001 but simultaneously reduced their holdings of
domestic bonds by R10.1 billion. The net outward
movement of portfolio capital totalled R3.4 billion in the
17
Mboweni Bundle SARB (7) 23-25
17
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
fourth quarter. This raised the total net value of
international portfolio capital outflows to R67.6 billion for
the calendar year 2001 as a whole, compared with net
outflows of R13.8 billion in 2000.18
(3)
Other investment
Other investment is the category of the international
capital that includes all transactions not covered by direct
investment and portfolio investment and consists of trade
credits, short-term and long-term loans and cross-border
bank deposits. On a net basis, other foreign investment
amounted to an outflow of R29.3 billion in 2001.19
5.9
The Governor summed up the impact of macro- economic factors
on the rand in 2001 as follows:
“….the macro-economic scene in South Africa in the fourth quarter of
2001 was characterised by total domestic expenditure exceeding total
disposable income. The excess of total domestic expenditure over total
disposable income was expressed in a deficit on the current account on
the balance of payments which was not matched by an inflow of
foreign investment capital into the economy. In fact, capital left the
country during the fourth quarter of 2001. This is a very significant
factor for the exchange rate’s behaviour during that period. Under
18
19
Mboweni Bundle SARB (7) 25
Mboweni Bundle SARB (7) 26
18
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
circumstances such as these, a depreciation in the exchange value of
the rand could be expected as a normal market reaction.”20
5.10
Dr O’Neill’s evidence was that the balance of payments of a
country should equal zero. The surplus on the one side should be
exactly the same as the deficit on the other side. If one has a
surplus in the current account, one should have a deficit in the
capital account. The capital account includes net FDI, net
portfolio flows (bonds and equities), short-term money flows and
the central bank foreign exchange reserve changes. In total, those
accounts should equal the current account. Dr O’Neill spoke
about a concept known as the “broad basic balance of payments”
(BBoP). BBoP is defined as the current account plus net FDI plus
net portfolio flows. The general proposition is that a country with
a BBoP deficit is likely to have a weak currency and a country
with a BBoP surplus is likely to have a strong currency:(1) The USA current account balance of payments has
deteriorated to such an extent that its deficit is about 4% of
GDP, the highest it has been since the early 1970’s. Despite
that deficit, the US dollar has strengthened against many other
currencies because the American BBoP has remained in
surplus. The reason for the surplus is that the USA has
20
Mboweni, Bundle SARB (7) 29
19
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
attracted large amounts of capital both in terms of portfolio
flows and FDI. Those capital flows have more than off-set the
US current account deficit.
Slide 13 O’Neill Bundle 14
13 US: BBoP & Current Account
US: BBoP & Current Account
2
% GDP
4-Qtr MA
1
0
BBoP
-1
-2
-3
Current Account
-4
-5
98
99
00
01
02
(2) In the early part of the euro’s existence, Europe21 had a small
current account surplus. But through 1999 and 2000 Europe
ran a large BBoP deficit, at times almost 4% of GDP. Europe
failed to attract foreign capital, either FDI or portfolio flows,
21
For the purposes of this discussion, Europe is equated with the euro zone.
20
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
and foreign capital left Europe for the USA and other parts of
the world.
Slide 15 O’Neill Bundle 16
Euroland:
Euroland: BBoP
BBoP &
&
Current
Current Account
Account
15
2
1
% GDP
12-mth MA
Current Account
0
-1
-2
-3
BBoP
-4
-5
98
99
00
01
02
As the BBoP deficit of euro declined, the trade weighted
exchange rate of the euro stabilised.
21
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Slide 16 O’Neill Bundle 17
16
Euroland:
Euroland: BBoP
BBoP &
& TWI
TWI
135
Index
% GDP
12-mth MA
130
GS TWI EUR
(LHS)
125
120
0
-1
-1
BBoP
(RHS)
-2
-2
-3
115
-3
110
-4
105
-4
TWI
Depreciation
100
98
99
-5
00
01
02
(3) For much of the period 1998 to 2002 Japan had a large current
account surplus and a BBoP surplus. (While Japan had a
BBoP surplus, the yen strengthened against the US dollar (as
shown on slide 1, O’Neill Bundle 2; §1.3 Part C).
22
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Slide 17 O’Neill Bundle 18
17 Japan: BBoP & Current Account
Japan: BBoP & Current Account
4.0
3.5
% GDP
12-mth MA
3.0
Current Account
2.5
2.0
1.5
1.0
0.5
0.0
BBoP
-0.5
-1.0
98
99
00
01
02
As the Japanese BBoP went into deficit, the value of the
yen declined. In short, the strong BBoP surplus is
associated with the yen’s strengthening, while the BBoP
surplus decline is associated with the decline in the value
of the yen.
23
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Slide 18 O’Neill Bundle 19
18
215
Japan:
Japan: BBoP
BBoP &
& TWI
TWI
Index
% GDP
12-mth MA
205
3.5
3.0
2.5
195
2.0
185
1.5
175
1.0
165
0.5
GS TWI JPY
(LHS)
155
145
TWI
Depreciation
0.0
BBoP
(RHS)
-0.5
135
-1.0
98
99
00
01
02
(4) The Mexican peso is one of the few currencies that has
strengthened against the US dollar in recent years. The reason
is that although Mexico has had a current account deficit, it
has had a BBoP surplus, due mainly to large FDI inflows.
24
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Slide 19 O’Neill Bundle 20
Mexico:
Mexico: BBoP
BBoP &
&
Current
Current Account
Account
19
4
% GDP
BBoP
3
2
1
0
-1
-2
Current Account
-3
-4
-5
98
99
00
01
02
The consequence is that the peso has appreciated against the
TWI.
25
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Slide 20 O’Neill Bundle 1
20
50
Mexico:
Mexico: BBoP
BBoP &
& TWI
TWI
Index
% GDP
55
4
3
60
TWI MXN
(LHS)
65
2
1
70
75
0
80
85
BBoP
(RHS)
TWI
Depreciation
90
98
99
-1
-2
00
01
02
(5) China does not have liberalised financial markets. It is not
generally possible for residents of China to buy foreign bonds
or foreign equities and it is not possible for foreign residents
to buy and sell Chinese equities or bonds. China does not have
a completely open capital account. The concept of narrow
balance of payments (“NBoP”) is thus used. NBoP consists of
the current account and FDI (and excludes portfolio flows).
China has a large NBoP surplus because it has attracted
26
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
massive FDI: in 2002 China may attract FDI in excess of 5%
of GDP.
Slide 21 O’Neill Bundle 22
21
China:
China: NBoP
NBoP &
& Current
Current Account
Account
10
% of GDP
8
NBoP
6
4
2
0
-2
-4
Current Account
-6
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01
The result is that since about 1995 there has been a slow steady
appreciation of the Chinese yuan or oemnimbi. The Chinese
currency would probably have strengthened more if it had not
been for the large accumulation of foreign exchange reserves by
the Chinese authorities.22
22
Evidence of O’Neill, Record 1478-1480
27
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Slide 22 O’Neill Bundle 23
22
China:
China: NBoP
NBoP &
& TWI
TWI
250
% of GDP
Index
10
8
CNY TWI
(LHS)
200
6
NBoP
(RHS)
150
4
2
100
0
-2
50
0
85
(6)
-4
TWI
Depreciation
87
89
-6
91
93
95
97
99
01
03
Because of the NOFP, it is very hard to talk about the
South African balance of payments in the same way as one
does of other countries. Dr O’Neill therefore referred to
the adjusted broad basic balance of payment or adjusted
BBoP. Adjusted BBoP is the current account plus FDI
plus portfolio flows plus the change in the NOFP. (The
reduction in the NOFP is in effect the same as a large
commercial outflow.) By and large, South Africa’s current
account balance has been very respectable for the past few
years. However, when one takes into account the NOFP,
28
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
the adjusted BBoP has been significantly in deficit since
1998.
Slide 24 O’Neill Bundle 25
24 South
South Africa:
Africa: Adjusted
Adjusted BBoP
BBoP
1.0
0.5
&
& Current
Current Account
Account
% GDP
% GDP
Current Account
(LHS)
0.0
40
35
30
25
-0.5
20
-1.0
15
-1.5
10
Adjusted BBoP
(RHS)
-2.0
5
0
-2.5
-5
-3.0
-10
-3.5
-15
98
99
00
01
02
Having regard to the deficit in the adjusted BBoP it is not
surprising that the rand depreciated in 2000. What is
surprising is that it did not do so sooner.
29
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Slide 25 O’Neill Bundle 26
South
South Africa:
Africa: Adjusted
Adjusted
BBoP
BBoP &
& TWI
TWI
25
75
85
% GDP
Index
Real TWI
(LHS, inverted)
95
35
30
25
105
20
115
15
Adjusted BBoP
(RHS)
125
135
10
5
145
0
155
-5
TWI
Depreciation
165
175
98
-10
-15
99
00
01
02
An analysis of the accounts making up the adjusted BBoP
quarter by quarter in 2001 shows that the adjusted BBoP
as a percentage of GDP was:
Q1
Q2
Q3
Q4
-0.7
-0.1
-3.4
-4.3
30
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
It is absolutely no surprise, therefore, that the rand fell
sharply in quarters three and four. The inference is that
there were large capital outflows.23
(b)
Perceptions/sentiment
6
6.1
During the latter half of 2001 there was a negative
perception about South Africa and its currency, the rand.
The
Governor
testified
that
regional
instability,
particularly in Zimbabwe, could have played some role in
the weakening of the rand from May 2000 and also from
June 2001. Other factors which the Governor said were
regularly mentioned in the market were perceptions about
unemployment, HIV/Aids, crime, the lack of progress with
further privatisation, labour reform and investment
incentives.24 In the joint press statement by the Governor
and the Minister of Finance of 21 December 2001 it was
stated: “Increased risk aversion and growing negative
sentiment towards the emerging markets have been further
23
24
Evidence of O’Neill, Record 1480-1484
Evidence of Mboweni, Bundle SARB (7) 38
31
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
fuelled by the Argentinean crisis. In our region, events in
Zimbabwe have also impacted negatively.”25 Mr Luüs, in
addition to the factors mentioned by the Governor, added
others, some of which were high and rising levels of
unemployment, threatening socio-economic stability; a
perceived lack of labour market flexibility, compounding
the unemployment problem and being detrimental to
higher productivity growth; low savings and fixed capital
formation levels, constraining the economy’s long-term
growth potential; dissatisfaction amongst poverty stricken
people because of growing economic illiquidity; the civil
service was considered to be bloated and inefficient; the
country’s infrastructure, notably railways and roads, was
not being maintained properly26. The factors, negative and
positive, which might have impacted on the rand are
shown graphically:
25
26
Bundle SARB (7) 347
Evidence of Mr CW Luüs, Chief Economist, ABSA Group Ltd, Expert Bundle 210, 211
32
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Graphs 4A and 4B Expert Bundle 222-223
Graph 4a
SA Rand
Rand per
per US
US Dollar
Dollar
SA
SARB: Forex
controls
Zimbabwe
9.40
9.15
Turkey,
Aussie Dollar
weakness
8.90
8.65
US ATTACK
& Emerging
market
concerns
Privatisation
delays &
squatters
Emerging
market risk
Aussie & euro
weakness
Rumours: Telkom
Kabila’s death
Euro weakness
8.40
Swissair &
SAA
Arms deal, euro
weakness & US
cut interest rates
unexpectedly
Argentina
Moody
considers
upgrade
8.15
PAC supports Zim
7.90
Graph 4b
SA Rand
Rand per
per US
US Dollar
Dollar
SA
Sanctions against
Zim opposed &
Tsvangirai
arrested
14.00
13.50
Rumours Manuel
resigned
Argentina's Cavello resigns
Interest rate hike
Statement by
SARB &
Treasury
13.00
12.50
23-Oct
09-Oct
25-Sep
11-Sep
28-Aug
31-Jul
14-Aug
17-Jul
03-Jul
19-Jun
05-Jun
22-May
24-Apr
08-May
10-Apr
27-Feb
13-Mar
30-Jan
13-Feb
16-Jan
02-Jan
7.40
27-Mar
7.65
NOFP
down to
US$4.8
DE BEERS
& trade
figures
Optimism before
budget & trade
figures.
Turkey stabilizes
SA inflation
concerns
Fears of interest
rate increases
12.00
11.50
James Cross
to retire
Zimbabwe &
Argentina
11.00
Exchange control
speculation
10.50
US$ strength
Argentina
10.00
Govt talking to
international
institutions;
MCell
SA GDP
growth figure
weak
9.50
MCell
payment
Argentina
gets IMF
support
Arms report
6.2
31-Jan
24-Jan
17-Jan
10-Jan
03-Jan
27-Dec
20-Dec
13-Dec
06-Dec
29-Nov
22-Nov
15-Nov
08-Nov
01-Nov
9.00
Mr Dykes27 testified that sentiment played an important role in
the rand’s weakness in 2001. Negative sentiment towards South
Africa was based partly on the Zimbabwe crisis and the emerging
27
Chief Economist for the Nedcor Group, Nedcor Bundle 7. See, too, the evidence of Bester,
FirstRand Bundle 18; De Villiers, Investec Bundle 36, Woollam, BoE Bundle 9; Morrison,
Deutsche Bank Bundle 12; Potgieter, Standard Bank Bundle 47-49; §39 Part D
33
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
market woes in the form of Argentina and Turkey. In regard to
Zimbabwe, contagion played a significant role in the minds of
both foreign and domestic investors. There were, generally
unspoken, fears that what had happened in Zimbabwe would be
repeated in South Africa at some point in the future. Any hint of a
threat to property rights – such as the episode regarding foreign
participation in the private security industry – provokes investor
fears. The situation in Argentina and problems in Turkey and
Indonesia, increased risk aversion during the year. However, the
situation was different to that of 1998 when contagion spread
from Asia to Russia to South Africa and on to Latin-America.
6.3
In reply to the question posed by Goldman Sachs to 30 of its
clients: “What is the biggest change that would be positive for the
rand?” 21% said Zimbabwe, 14% said Aids and 10% said crime.
It follows that 40% of the responses related to Southern African
related concerns. 28
6.4
The authorised dealers, in their replies to the Questionnaire29 in
describing what factors influenced the rapid depreciation of the
rand in 2001, referred, inter alia, to poor emerging market
sentiment; emerging market contagion; economic problems in
28
29
See §36 Part D below
See §41 Part D below
34
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Argentina; Zimbabwe and South African political factors. There
was “generally poor market sentiment”.
The common factor
influencing the rapid depreciation of the rand amongst the
representative offices of the foreign banks was the political and
economic instability in Zimbabwe.30
6.5
Conservative estimates had put the foreign currency inflows from
privatisation in the 2001/2002 budget at R18 billion. The actual
proceeds were only R2.3 billion. In Dr Abedian’s words: “This
had both perceptual and forex inflow implications. The rand had to be
31
priced accordingly.”
Dr Jammine emphasised the importance of
privatisation from the point of view of foreign investors: they
“saw privatisation almost as a litmus test of the government’s
32
commitment to investor friendly economic policies”.
6.6
A view is that the exchange controls which are still in force
potentially deter foreign investment because foreigners believe
that the gradual or sudden removal of such controls would lead to
a gradual or sudden further depreciation of the rand; the partial
lifting of exchange controls over the years has probably made the
enforcement of the remaining measures much more difficult; and
remaining exchange controls are rendering the rand a weak
30
31
32
See §42 Part D below
Abedian Expert Bundle 275-6
Jammine Expert Bundle 315. See, too Luüs, Expert Bundle 211-212
35
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
currency because of the fear that comprehensive exchange
controls may again be implemented at any time.33
(3)
Short term
(a)
The role of the Reserve Bank
7
Exchange Rate Management
7.1
Mr McCauley testified that few countries are indifferent to the
exchange rate. While the objectives of managing an exchange rate
differ, there are six established objectives of exchange rate
management:
Macro-economic concerns:
-
prevent depreciation from raising inflation to unacceptable
levels;
-
prevent depreciation from undermining competitiveness of
exports and thereby undermining incentive to invest in
export industry;
-
prevent depreciation from ballooning debts denominated
in foreign currency, particularly those of government;
33
Luüs Expert Bundle 213; see, too, Gouws, Record 94
36
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Micro-economic concerns:
-
reduce volatility of exchange rate;
-
prevent loss of confidence: fear that decline may lead to
expectations of further decline and lead normal players to
back away from the market;
-
prevent “disorderly” market as reflected in “gapping” of
successive bid–ask spreads, widening of bid-ask spreads
and an absence of a sense of two way risk.34
7.2
The instruments to manage an exchange rate are:
-
“open mouth” policy;
-
intervention;
-
moving interest rates;
-
imposing or tightening capital (exchange) controls.
Open mouth policy
This is almost universally used by policy makers. A person in
authority, such as the minister of finance or the governor of the
central bank, makes a statement about the exchange rate with the
object to influence the exchange rate, for example, “I think a
strong dollar is in the interest of the US economy”. 35
34
35
McCauley Expert Bundle 60 - 61
McCauley gave this example: “… in the Philippines last August, the President….said that she
thought that 50 pesos to the dollar was a pretty good exchange rate for the peso. It was then
trading at more like 55 and strangely enough by the end of the year it was down to close to
50.” Record 68
37
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Intervention to support currency
Intervention can be done quietly or openly. Intervention may take
place in different ways, for example, by sending the signal that
interest rate hikes are likely to follow or through the portfolio
effect by the central bank buying the domestic currency, which
has the effect of offsetting the result of somebody selling the
currency. This is particularly effective in a smaller country. The
constraints of intervention by a central bank supporting the local
currency are, for example, the concern that the intervention will
be ineffectual and a waste of money, and the size of reserves –
the central bank must have the wherewithal (reserves) to be able
to support the domestic currency.
7.3
Raise interest rates to defend currency
Until quite recently, it was generally accepted that if a currency
was under pressure, an effective way to defend the currency was
to raise interest rates. But it may be hard to influence the
exchange rate in a particular way: high interest rates can hurt
growth and many investors associate growth with a strong
currency and high interest rates may lead to a sale of bonds. The
limits to the effectiveness of this kind of response were shown in
the United Kingdom in 1992 and in the case of Europe in the past
38
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
15 months. The market has come to the conclusion, according to
McCauley, that “the best thing for a currency is the prospect of
growth returning to that economy and so raising interest rate or only
slowly lowering them, might actually perversely hurt the currency
rather than help it. So that is a pretty radical notion I have to admit, one
that goes very much against the text books and everything they teach
central bankers but there has been a suspicion out there that that is the
way it is working actually.”36
7.4
Tighten capital (exchange) controls
Exchange controls can take various forms, such as restrictions on
borrowing lower yielding foreign currencies, on non-resident
borrowing of local currency; and on residents purchasing foreign
currency. The tightening of non-resident borrowing of local
currency can immediately lift the domestic currency. The
downside is that the longer term effects of such a policy are
harder to gauge and there is an argument that by tightening
exchange controls, you actually curb inflows.37
36
37
McCauley Record 78
McCauley Record 79 - 80
39
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
The Reserve Bank
8
The Reserve Bank was established in 1921 as the central bank of South
Africa in terms of the Currency and Banking Act, 31 of 1920. That Act
was replaced in 1944 by the South African Reserve Bank Act, 29 of
1944. In 1989 a new Act was introduced, the South African Reserve
Bank Act, 90 of 1989 (“the Reserve Bank Act”), which is still in force.
In terms of the Constitution of the Republic of South Africa, 108 of
1996, (“the Constitution”) and in terms of a 1996 amendment to the
Reserve Bank Act, the primary object of the Reserve Bank is to protect
the value of the currency of the Republic in the interest of balanced and
sustainable economic growth in the Republic. The Reserve Bank enjoys
an important degree of autonomy for the execution of its responsibilities
in respect of domestic monetary policy. As far as exchange rate policy is
concerned, however, the Reserve Bank and the Government are jointly
responsible for determining the framework of policy. The day-to-day
implementation of that policy is the function of the Reserve Bank.38
38
Mboweni, Bundle SARB (7) 5-7
40
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Reserve Bank policies
9
In January 1979 the Government accepted this recommendation of the
De Kock Commission of Enquiry into the Monetary System and
Monetary Policy in South Africa: “The Commission recommends a unitary
exchange rate system under which an independent and flexible rand finds its
own level in well-developed and competitive spot and forward foreign
exchange markets in South Africa, subject to Reserve Bank ‘intervention’ or
‘management’ by means of purchases and sales of foreign exchange (mainly
US dollars), but with no exchange control over non-residents and limited
control over residents”. The De Kock Commission further recommended:
“…whatever other objectives it (the Reserve Bank) might also have from time
to time, intervention (in the foreign exchange market) should ordinarily be a
smoothing operation.” It was only after 1994 when South Africa could
afford to commence phasing out exchange controls that the South
African forex market reached the full status envisaged by the De Kock
Commission and the “managed floating exchange rate” system for the
rand was fully applied.39
39
Stals, Expert Bundle 167–9; 179
41
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
10
On various occasions in the past the Reserve Bank intervened in defence
of the rand. As the Reserve Bank did not have adequate foreign reserves,
the obligations to deliver foreign exchange into the market were
converted into forward obligations. The Reserve Bank, for example, sold
US dollars into the spot foreign exchange market in order to support the
exchange rate of the rand and then swapped the US dollars back onto its
forward book by buying US dollars spot and simultaneously selling
them forward. According to the Reserve Bank Act, all profits and losses
in respect of providing forward cover are for the account of
Government. Over the years, huge losses were made owing to the
existence of the NOFP.
11
In 1998 the Reserve Bank intervened in defence of the rand in two
distinct ways: by use of the forward book, increasing the NOFP to
USD23 billion and by raising interest rates from 14% in June 1998 to
25.5% in August 1998.40
12
By 2001 the Reserve Bank and the National Treasury had changed
course.
40
Jammine, Expert Bundle 309,310
42
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
13
Inflation targeting
13.1
A new monetary policy – inflation targeting – was introduced on
6 April 2000. Since then, the emphasis, in compliance with the
Constitution, has been on domestic price stability, i.e. the
reduction of inflation to lower levels in order to contribute
towards balanced and sustainable economic growth.
13.2
The evidence of the Governor was that inflation targeting is a
monetary policy framework implying the targeting of the inflation
rate directly. Other intermediate variables influencing inflation
such as money supply, credit extension or the exchange rate are
not targeted directly, although they still play an important role in
the determination of inflation. In the medium to longer term,
successful inflation targeting should contribute to a more stable
exchange rate for the rand.41 Dr Stals said in evidence that he
supported the concept of inflation targeting but that “… in any
central bank the Governor has in his drawer much more than just an
inflation target in mind because … in economics everything depends
on everything else and the inflation target or the inflation result will be
affected by a lot of other things that you just cannot ignore because …
the Reserve Bank does not fix prices everyday and therefore it does not
41
Mboweni, Bundle SARB (7) 9
43
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
control inflation directly. It affects inflation through its operations in
the money market, in the exchange rate environment, in the interest
rate structure, in the liquidity of the banking system. So these are the
operational instruments that you have to use and have to apply and
have to take account of every day even if you have a fixation on
inflation at the end of the day and ….whether that target of yours is the
money supply or the level of interest rates or the amount of liquidity in
the banking system or the bank credit extension or the exchange rate,
they are all very much inter-related in a circular process – the one
affects the other.” 42
13.3
In the Monetary Policy Review of the Reserve Bank dated March
2001 it was stated:
“Inflation targeting requires nominal exchange rate flexibility. In South
Africa’s case a fully flexible exchange rate regime has been adopted.
This means that there is no specific target for the exchange rate. It does
not however mean that the Reserve Bank is not concerned about the
exchange rate, as exchange rate changes do feed into the inflation
process. A depreciation of the currency directly affects the price of
imports. Then there are the possible second-round effects where higher
import prices feed into wage and other price increases.”
13.4
It is the view of Dr O’Neill that inflation targeting is very
important for South Africa and the rand has great relevance in the
42
Stals, Record 286
44
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
context of inflation targeting. But the importance of the rand
separately from inflation targeting from a global and analytical
perspective is somewhat overstated.43 The slide below shows how
CPIX inflation has performed against target. What happened in
the operation of the policy of inflation targeting is a lot more
important than the topic of the rand. Policy should be focussed on
inflation, not the rand. The target of 3-6% annual inflation should
be achievable over the next 12 to 18 months.44
Slide 27 O’Neill Bundle 28
27
10
9
CPIX
CPIX Inflation
Inflation
% Chg. YOY
8
7
6
Target
3-6%
annual
5
4
3
Forecast
2
1
0
98
43
44
99
Evidence of O’Neill, Record 1462
Evidence of O’Neill, Record 1488
00
01
02
03
04
45
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
13.5
The price of crude oil is included in the way CPIX is arrived at in
South Africa. Different crude oil price scenarios have different
outcomes for CPIX. In the opinion of Goldman Sachs, the fair
value of the rand is R7 to the US dollar and the price of crude oil
should be USD20 to the barrel. If those assumptions are met,
South Africa will meet its inflation target.45 South Africa,
however, has no control over the price of crude oil. In most other
countries which have inflation targeting, the price of crude oil is
not included in the calculation of the target inflation rate for these
reasons:
-
crude oil prices are not under their control; and
-
in the past, large movements in oil prices impacted
consumer price inflation but did not have lasting
underlying inflation consequences.46
13.6
Partly because of the move to inflation targeting and partly
because of the Government’s exposure to the NOFP, the Reserve
Bank did not use the forward book to finance intervention in
support of the rand in 2001.47
13.7
The policy of non-intervention was made public by the Reserve
Bank on a number of occasions in 2001 at a time when the rand
45
46
47
Evidence of O’Neill, Record 1496
Evidence of O’Neill, Record 1490-1493
Mboweni, Bundle SARB (7) 15, 247
46
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
was in decline. For example, in the Governor’s statement of 14
October 2001, it was said that “….with the adoption of an inflationtargeting monetary policy framework, [the Reserve Bank] no longer
has any intermediate policy targets or guidelines such as the exchange
rate or growth in the monetary aggregates. The authorities are
committed to continue allowing the value of the rand to be determined
by the market, but are concerned that excessive volatility in the foreign
exchange market negatively influences inflation, business decisions
and the economy as a whole.” Participants in the forex market
formed the view that in the absence of support for the rand by the
Reserve Bank, the rand would continue to depreciate. The policy
of non-intervention became an element of the “one-way bet” view
of the rand which infected the forex market in 2001.48
48
Gouws, Expert Bundle 125; Mr M Langley, former Head of Foreign Exchange, Credit
Agricole Indosuez, Johannesburg, Expert Bundle 148; Jammine Expert Bundle 339;
Mr G Glynos, chief market analyst, Standard & Poor’s MMS SA, Expert Bundle 424
47
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
14
NOFP
14.1
The Reserve Bank and the National Treasury took a decision to
reduce the NOFP. The decision was made public and
implemented. By the end of the first quarter of 2001 the NOFP
had been reduced from USD23 billion in 1998 to USD9.4 billion.
14.2
The Reserve Bank reduced the NOFP, in its words, by “buying
foreign exchange” or, in the words of the rating agency, Standard
and Poor, by “mopping up inflows”. Total purchases in 2001
amounted to about USD4.4 billion and were related to
Government’s foreign bond issues and to large corporate
transactions. The NOFP, accordingly, declined to USD5.3 billion
at the end of quarter two; USD4.7 billion at the end of quarter
three and USD4.8 billion as at the end of 2001.49 The Reserve
Bank’s success in implementing the policy is shown in this graph:
49
Mboweni, Bundle SARB (7) 33
48
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Graph 13 Bundle SARB (7) 70
The net oversold open forward position of the SARB since 1994
US$ million
21000
14000
7000
Dec-2001
Jul-2001
Feb-2001
Sep-2000
Apr-2000
Jun-1999
Nov-1999
Jan-1999
Aug-1998
Mar-1998
Oct-1997
May-1997
Dec-1996
Jul-1996
Feb-1996
Apr-1995
Sep-1995
Nov-1994
Jan-1994
Jun-1994
0
Graph 13
G13 - The net oversold
open forward position
14.3
The policy of reducing the NOFP has been praised by the IMF,
the rating agencies and the investment banking community. For
example, on 9 May 2001 the IMF stated: “Directors [of IMF]
commended the authorities for the significant recent progress made in
reducing the net open forward position (NOFP) of the Bank.
Nevertheless, they noted that the NOFP remains an important source of
external vulnerability, and that it needs to be further reduced as market
conditions permit”.50
50
Mboweni, Bundle SARB (7), 31
49
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
14.4
The experts from the private sector, whether economists or
traders, were not critical of the policy. But all agreed that the
Reserve Bank’s commitment to reduce the NOFP by buying US
dollars contributed significantly to the perception that the rand
was a one-way bet.51 As Dr Abedian said: “… The SARB’s single
minded focus was on eliminating the NOFP … This of course meant a
one-sided intervention in the spot market. The SARB was in principle
selling rands and buying hard currency, thereby adding to the net
demand for hard currency and putting downward pressure on the rand.
Moreover, in pursuit of closing down its NOFP, the SARB seemed to
be inclined to fully capture once-off inflows such as the De Beers deal,
thereby eliminating any upward pressures on the value of the rand. This
proved a consistent policy approach over the period 1999-2001.
However, this approach had a significant impact on hardening positions
against the currency. Speculative positions against the rand were
therefore by and large risk free. In essence, most, if not all, market
players believed that even the SARB was neither inclined nor in a
position to do anything that would strengthen the currency.”52
14.5
The apparent correlation between the reduction of the NOFP and
the decline in the value of the rand is shown in these two graphs:
51
52
For example, Gouws Expert Bundle 126; Langley Expert Bundle 148; Luüs
Expert Bundle 213.
Abedian; Expert Bundle 273. See, too Jammine, Expert Bundle 337, 338.
50
51
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Graph 18 Expert Bundle 126
Chart 3 Expert Bundle 455
CHART 3
RELATIO NS HIP BETW EEN T HE T RADE W EIG HTED ZAR AND T HE
NO F P
25000
110
NO F P
100
20000
90
15000
TW ZAR
80
10000
70
5000
60
0
50
98
14.6
99
00
01
02
The Reserve Bank does not have a different view. The evidence
of the Governor was:
“Given the losses on the forward book and negative perceptions from
market participants and commentators on the one hand and the
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
potential impact on the currency of reducing the forward book on the
other, the Bank had a difficult choice to make. In the long-term interest
of South Africa, it was decided to place emphasis on reducing the
NOFP. The Bank had to buy foreign exchange as prudently as possible
to close out the NOFP.
It is quite possible, however, that this eminently defensible goal of
reducing the NOFP could have contributed at times to the sentiment
that the rand’s value is a one-way bet. To reiterate, the Bank was
indeed conscious of this risk in pursuing its goal and strove to manage
this risk by buying US dollars selectively. …..
Had the Bank allowed the proceeds of these large corporate
transactions to flow through the market, the rand could have
appreciated significantly. The market had been expecting a sizeable
amount of the foreign exchange proceeds accruing to South African
shareholders to be sold off for rand in the market, which expectation
initially provided some support for the rand. Upon confirmation that
the bulk of such proceeds were to be the subject of a once-off
transaction with the Bank, for the purpose of reducing the NOFP,
53
market perceptions of rand weakness could have been reinforced.”
14.7
On 14 October 2001 the Governor issued a statement which dealt,
inter alia, with the NOFP in these terms: “The net open foreign
currency position (NOFP) has declined from USD23.2 billion at the
53
Mboweni, Bundle SARB (7), p 32 – 33
52
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
end of September 1998 to USD4.8 billion. Given the negative
perceptions resulting from the NOFP, the Reserve Bank reduced this
position by purchasing foreign currency in the domestic foreign
exchange market, which may have contributed to the depreciation of
the rand over this period.
The South African Government’s exposure to foreign currency risk,
including the NOFP, as a percentage of GDP, is now on par with those
prevailing in certain G10 countries. With the NOFP at a more
comfortable
level,
any
perceived
vulnerability
has
declined
significantly. The Reserve Bank is consequently in a position to alter
its approach in dealing with the NOFP.
In future, the Reserve Bank will not intervene by purchasing foreign
exchange from the market for purposes of reducing the NOFP. The
NOFP will be expunged from cash flows derived from the proceeds of
54
Government’s off-shore borrowings and privatisation.”
14.8
Had investors and analysts read the statement of 14 October 2001
with the necessary care, they would have realised that as the
Reserve Bank would no longer “mop up” US dollars in the forex
market to reduce the NOFP, the NOFP should not be considered
an element of the one-way bet. The evidence before the
Commission leaves one with the impression that the statement
was either not read properly or ignored.
54
Mboweni, Bundle SARB (7), 340
53
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
14.9
On 21 December 2001 the Governor of the Reserve Bank and the
Minister of Finance issued a joint statement. One of the matters
addressed in the statement was the NOFP: “The NOFP is down to
$4,8 bn from $23,86 [bn] in September 1998. In January 2002,
Government will be drawing down the full $1,5 bn syndicated loan,
further contributing to reducing the NOFP, which is expected to be
expunged entirely during 2002. This will be achieved utilising funds
available
from
Government
borrowing
and
proceeds
from
privatisation, and not from any purchases of foreign exchange in the
market.”
14.10 The Government did indeed increase its foreign borrowings in
2001, including a syndicated loan of USD1.5 billion, and the
Reserve Bank was able to reduce the NOFP to USD2.9 billion as
at the end of January 2002.55 The NOFP at the end of March 2002
was still USD2.9 billion and “has ceased to be the major concern
to the international investment community.”56
55
56
Ramos, National Treasury Bundle 57, 66
Statement of Minister of Finance on 24 May 2002: Record 1759-1760
54
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
15
The meeting of 14 October 2001 and the communications that followed
15.1
The evidence of the Governor was that the issue of enforcing
existing exchange controls had been extensively discussed in the
Reserve Bank and with National Treasury over a long period of
time. The Reserve Bank was aware of the various explanations of
the rand’s weakness in recent years. The explanations included
exchange control liberalisation, the Reserve Bank buying spot
foreign exchange to reduce the NOFP and the decisions by
importers and exporters to lead or lag their foreign exchange
payments and sales. The impact of these more fundamental and
legitimate factors influencing the exchange rate was acceptable to
the authorities. Of more concern were comments from the market
that speculative transactions, particularly by non-residents, were
adding to volatility and rand weakness. The Reserve Bank was
informed that investors and other emerging markets, with less
liquid financial markets, were using South African markets as a
proxy hedge for weakness in other countries. The Reserve Bank
had no choice but to either abolish the remaining exchange
controls in total or to apply the existing rules and regulations
equitably to all. The Reserve Bank became increasingly
55
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
concerned that excessive volatility in the forex market during the
third quarter of 2001 negatively influenced inflation, business
decisions and the economy as a whole. Accordingly, a meeting
was called on Sunday, 14 October 2001 between the Reserve
Bank and the chief executive officer and head of treasury of
major South African and foreign banks registered in South Africa.
What was conveyed to the banks, and which is material for
present purposes by the Governor, is what is contained in the
statement of 14 October in these terms:
“The Reserve Bank stands ready to take appropriate firm steps against
trading activities inconsistent with existing rules and regulations. The
enforcement of existing rules serves to ensure that only legitimate
transactions take place in the foreign exchange market. This does not
restrict, for example, the ability of a non-resident investor to either
hedge or repatriate the sale proceeds of an investment in South Africa.
It does, however, exclude the financing of short rand positions in the
domestic markets, which is consistent with the requirement that
domestic borrowing by non-resident investors is subject to certain
restrictions. This communication should not be construed as an attempt
to restrict the activities of banks in the South African markets,
provided they adhere to the existing rules and regulations. Normal
commercial and financial transactions remain unaffected.” On 16
56
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
October 2001 the Reserve Bank issued Circular D342, in which it
was stated, inter alia:
“To ensure that the provisions of the various sections of exchange
control rulings are applied uniformly by all authorised dealers, in
particular when dealing with non-residents in the forward and other
derivative foreign exchange markets, we deem it necessary to reiterate
certain fundamental principles in this regard.
It is incumbent upon authorised dealers to ensure that their overseas
counterparties are fully conversant with the rules applicable to dealing
in the domestic forward and other derivative foreign exchange markets.
It follows, therefore, that when dealing with a non-resident counterparty, other than a correspondent bank, supporting documentary
evidence must be obtained confirming that such non-resident counterparty has a legitimate South African exposure resulting from an
57
accrual, investment or asset denominated in rand.”
15.2
On about 25 October 2001, an “important notice” was issued to
authorised dealers. In terms of the notice, the compliance officer
of a non-resident bank was required to sign a compliance letter.
The Reserve Bank and a working committee of the ACI, an
organisation representing forex dealers, accepted the wording of
the compliance letter. In terms of the compliance letter, the
57
Mboweni, Bundle SARB (7) 42, 43, 340, 342; Evidence of Mr AM Bruce-Brand, General
Manager Exchange Control Department, Bundle SARB (6) 22
57
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
compliance officer was called upon to confirm in writing “that all
transactions concluded by our clients and our dealers within the
preceding 14 business days have been in compliance with the
applicable rules and regulations.”58
15.3
The Reserve Bank believed that applying the existing rules and
regulations to exclude speculative trading from the forex markets
would reduce volatility in the rand’s exchange rate and would be
to the benefit of non-resident investors and South Africans
alike.59
15.4
The exchange controls which the Reserve Bank sought to enforce
were these:
“21.5.3
Forward exchange contracts with South African
residents – Foreign currency may be sold forward to
South African residents, provided that the facilities are
required to cover a firm and ascertained foreign
exchange commitment due to a non-resident. Foreign
currency may be purchased forward from South African
residents, provided that the facilities are required to
cover a firm and ascertained foreign currency accrual
due from and payable by a non-resident.
58
59
Evidence of Bruce-Brand, Record 568, Bundle SARB (6) 224-5
Mboweni, Bundle SARB (7) 43
58
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
21.5.4
Forward exchange contracts with non-residents –
Foreign currency may be sold forward to non-residents,
provided that such non-resident counterparties have
legitimate South African exposures resulting from an
60
accrual, investment or asset denominated in Rand.”
15.5
The Reserve Bank surmises that while consultation between it
and the forex market was taking place following on the statement
of 14 October 2001, “… some off-shore banks might have decided,
as a precautionary measure, to avoid finding themselves in
contravention of exchange control rules, to reduce the level of activity
in South Africa’s foreign exchange markets. This may well have
contributed to a decline in liquidity …”.61
15.6
The average net daily rand forex market turnover declined from
USD8 billion in July 2001 to USD7.4 billion in October 2001 to
USD5.5 billion in November 2001 and then increased to
USD6.1 billion
in
December
2001.
demonstrated as follows:62
60
61
62
Bruce Brand, Bundle SARB (6) 18, Record 558-9
Mboweni, Bundle SARB (7) 44
Mboweni, Bundle SARB (7) 44; Gouws, Expert Bundle 125
This
is
graphically
59
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Diagram 15 Expert Bundle 125
The most significant decline was in the swap market where the
average daily net turnover declined from an average level of
USD5.8 billion in the first ten months to an average
USD4.3 billion for the last two months. The turnover of nonresidents – the most significant participants in the market –
declined from USD3.6 billion to USD2.3 billion respectively.63
15.7
The Governor expressed the view that liquidity in the forex
market could have been affected by the statement of 14 October
2001. He went on to say:
“The issue of liquidity also arises when considering volatility. Onemonth historical volatility of the rand’s exchange rate against the US
63
Mboweni, Bundle SARB (7) 44
60
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
dollar increased from a level of 9.1% in the first nine months of 2001
to an average of 20.5% for the last quarter. These volatilities reached a
high of 55% at the end of December 2001. It is, however, not possible
to attribute changes in these variables to a single reason or event but it
is possible that the interpretation of the 14 October 2001 statement
could have been a contributory factor.”64
15.8
A view that was expressed by a number of economists was that
the effect of the statement of 14 October 2001 on the rand was
negative. For example, Mr Luüs said: “On 14 October 2001 the
SARB drained liquidity from the foreign exchange market by a stricter
application of foreign exchange regulations. This measure worsened
the rand’s slide”.65 Dr Abedian testified that the immediate impact
of the statement of 14 October 2001 was to “scare away the pure
speculators (mainly off-shore) from the market, thereby reducing
liquidity in the overall market by another USD200 to USD300 million
per day. In an already thin market, this contributed considerable
additional pressure on the rand. With these volumes out of the market
and no speculators active in the market, the conditions were so much
more favourable for a run on the currency.”66
15.9
During a volatile forex market, such as South Africa experienced
in the fourth quarter of 2001, “… many smaller players, that are
64
65
66
Mboweni, Bundle SARB (7) 45
Luüs, Expert Bundle 213
Abedian, Expert Bundle 273 See, too, Glynos, Expert Bundle 432
61
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
normally active in calmer market conditions, simply withdraw from a
volatile market resulting in a sharp decrease in liquidity.”67 Foreign
financial institutions, based mainly in London and to a lesser
extent in New York, have entered the South African forex market.
When volatility is at its highest, however, a number of new
entrants leave the market.68
15.10 In about the first two days after the meeting of 14 October 2001
the rand appreciated. This was “… a natural consequence of traders
sitting on-shore and off-shore that were holding long dollar positions,
getting out of their long dollar positions by selling those positions and
buying rand until they were confident that they understood what the
implications of the circular were …”69 Once the market understood
the import of this statement, the rand continued to depreciate. The
volumes dropped because of the reduced number of market
markers in the market. The market makers which left the market
were the foreign market makers. The probable reason for their
withdrawal from the market was that a compliance officer of a
foreign bank is in a very responsible position. He would not
certify that a forex transaction was not for speculative purposes
unless he was satisfied about the truth of the averment.
67
68
69
Langley Expert Bundle 141
Mr P De Villiers, Global Head of Foreign Exchange Trading, Investec Bank, Record 363
De Villiers Record 388
62
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Compliance officers of foreign banks probably advised their
banks not to trade in the rand until they understood the statement
of 14 October 2001 and could satisfy themselves that they were
able to comply with the exchange control regulations.70
15.11 In the Questionnaire,71 the authorised dealers were asked the
following questions:
“4.6.2.5
The extent to which your organisation’s procedures to
ensure compliance with Excon differed pre and post 13
October 2001?
4.7
Provide detail on compliance certificates received by
your organisation from non-resident banks before and
after 13 October 2001. Provide reasons for any changes
in the provision of compliance certificates before and
after this date.” The major authorised dealers
canvassed these issues at some length in their
evidence before the Commission:15.11.1
Absa
Absa’s evidence was that the “stricter enforcement
of Circular D342 in mid-October [2001]”72 resulted
in an immediate liquidity drain when market
70
71
72
De Villiers Record 383
The Questionnaire is the one sent by the Deloitte & Touche team to authorised dealers
referred to in Part K.
Evidence of Balt, Absa Bundle 14-15
63
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
participants complied with the Circular. The result
was an expansion in the second-tier rand market
outside South Africa, the widening of bid/offer
spreads and a decrease in the pool of market
participants. After 14 October 2001, the number of
participants dealing directly with the rand market
makers decreased, resulting in a decrease in
turnover and the widening of bid/offer spreads.
The market became imbalanced due to the lower
liquidity. As a consequence, the risk of holding
rand became unacceptable and caused a severe
reduction in foreign exchange supplied to the
market.
15.11.2
Nedcor
Nedcor testified that the Circulars dated 15 October
2001, D341, and 16 October 2001, D342, differed
in some respects from what had been understood at
the meeting with the Governor on 14 October 2001.
The
perceived
amongst
both
differences
domestic
caused
and
confusion
international
participants and reduced market participation and
therefore liquidity. Foreign banks generally were
64
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
not happy with the measures being taken. Some of
them sought legal advice, which was that the banks
should not submit the required compliance letters.
The Circulars were one of the many factors which
contributed to the depreciation of the rand as they
drew attention to concerns about the market but did
not prevent ongoing speculation against the rand.
When the Reserve Bank re-confirmed that nonresidents were free to hedge in circumstances where
the rand was extremely volatile, the concern was
that whereas non-residents had not hedged the
underlying exposures in large volumes previously,
this might turn out to be the case thereafter. The
markets therefore became increasingly nervous.
Under the circumstances, some foreign players reassessed their involvement in the rand market,
further exacerbating illiquidity.73
15.11.3
FirstRand
In the view of FirstRand Bank, Circular D342 was
issued with good intentions, but did not achieve the
desired results. The market incorrectly interpreted
73
Evidence of Parker, Nedcor Bundle, 19-20
65
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
the Circular as a re-introduction of exchange
controls, despite the Reserve Bank’s clear message
that it was merely reiterating the current exchange
control rules. The Circular contributed to a
reduction in liquidity due to the lack of clarity of its
interpretation. This was another factor adding to
increased volatility in the rand currency markets at
the time.74
15.11.4
BoE
BoE contended that one of the factors that led to the
rapid depreciation of the rand was “the D342
Circular and the uncertainty that it generated concerning
Reserve Bank policy”.75
15.11.5
Investec
The evidence of Investec was that one of the seven
most important factors which influenced the
depreciation of the rand was “the introduction of
SARB Circular D342 on 15 October 2001, which
caused a massive decrease in liquidity in the market”.
The introduction of Circular D342 dated 15
74
75
Evidence of Bester, FirstRand Bundle, 21-22
Evidence of Woollam, BoE Bundle, 8-9
66
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
October 2001 and Circular D345 dated 7 November
2001 created substantial negative sentiment in the
market. Circular D342 was perceived to involve a
tightening of exchange control regulations, while
circular D345 was seen as a re-introduction of
exchange control as the dispensation allowing
authorised dealers to accept US dollars as collateral
from foreign borrowers of securities was removed.
There was also great confusion and local authorised
dealers were uncertain whether they were able to
continue making markets to foreign counter parties.
This uncertainty and lack of confidence in the
currency caused a marked decrease in liquidity as
well as a drastic increase in intra-day volatility at a
time when the market required liquidity and
stability.76
15.11.6
JP Morgan
Prior to 14 October 2001, JP Morgan was an active
market
maker
in
spot
and
forward
forex
transactions. The market was characterised by high
levels of activity as a result of the presence of
76
Evidence of de Villiers, Investec Bundle, 36, 38
67
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
numerous other market makers in Johannesburg,
London and New York. This ensured that pricing
spreads in the market were kept at a relatively low
level. Following the release of Circular D342 on 16
October 2001, market participants, particularly offshore players, were initially uncertain about its
implications and application, resulting in many offshore institutions ceasing or reducing their market
making activities in spot rands. This in turn
significantly reduced liquidity in the market and
pricing spreads accordingly began to widen
considerably. The release of D342 did not, in itself,
cause a depreciation of the rand. Initial uncertainty
concerning the implications and application of the
circular led to illiquidity and a widening of trading
spreads. The adverse effect of other factors on the
rand was exaggerated by these more illiquid trading
conditions.77
77
Evidence of Coulter, JP Morgan Bundle, 16-17
68
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
15.11.7
Deutsche Bank
Deutsche Bank is of the view that Circular D342
could have had the effect of changing the market
structure and as result the conduct of participants in
the markets.78
15.11.8
SCMB
On 15 and 16 October 2001 authorised dealers
communicated with their overseas counterparties
and informed them of the reinforcement of the rule
that only counterparties that have confirmed South
African exposures, resulting from an accrual
investment or asset denominated in rand, could
hedge the transaction in the South African forex
market and that authorised dealers need to view
applicable documentary evidence within 14 days
after dealings took place. During this period nonresident banks assessed their positions and foreign
bank dealings almost came to a halt.
A debate followed during the next three days
between authorised dealers, the ACI and the
78
Evidence of Morrison, Deutsche Bank Bundle, 13
69
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Reserve Bank in order to establish which
transactions were affected and the treatment of
transactions originated by South African authorised
dealers with non-resident market making banks. By
19 October 2001 it was clear that foreigners could
continue trading in the spot market.79 On 25
October 2001 the bank conveyed to all its
correspondent banks the requirements agreed
between ACI and the Reserve Bank, which
included a reference to the certificate which had to
be signed by the compliance officer of a nonresident bank.
In the following weeks, the bank was inundated
with calls from non-resident banks seeking further
clarity. Banks who had legitimate transactions were
concerned about the negative effects of the events
being interpreted as a general tightening of
exchange control rules.
15.11.9
The bank has contacted all non-resident bank
account holders and taken steps to obtain the
compliance certificates required. About 55% of
79
Evidence of Van Zyl, Record 1694
70
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
foreign banks have not provided their compliance
certificates. Where the compliance certificates have
not been forthcoming, the bank has reported the
instances to SARB.80
Since October 2001, off-shore banks reconsidered
their activities in the South African market. Many
banks were no longer prepared to risk noncompliance with South African exchange control
rules and restricted trades to underlying South
African assets, with a result in drop in turnover and
market making activities. This caused a shrinkage
in turnover, now restricted to trade related and
confirmed capital transactions, and a distinct
difference between the activities of local authorised
dealers and their off-shore counterparties, with a
real possibility of a two-tier market developing.81
15.12 A summation of the replies received from the authorised dealers
by Deloitte & Touche to the Questionnaire is that non-resident
banks, unwilling to contract subject to the compliance obligations
of D342, ceased their market making activities in spot rand. The
80
81
Evidence of Potgieter, Standard Bank Bundle 41-43
Evidence of Potgieter, Standard Bank Bundle 50
71
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
majority of the material authorised dealers were active market
makers in the foreign exchange market before 14 October 2001.
The majority did not change this role after 14 October 2001.
However, some authorised dealers found their market making
role increased as non-resident banks withdrew from the market.82
15.13 Dr O’Neill’s evidence was that he arrived in Johannesburg on the
morning of 15 October 2001. It bothered him that in the context
of inflation targeting, so much attention was being given to
exchange controls. It made him nervous about the commitment to
inflation targeting.
Dr O’Neill was further of the view that since 14 October 2001,
turnover in the spot market declined and that decline might well
have contributed to the size or speed of the depreciation of the
rand.83
15.14 The Reserve Bank mounted a spirited defence of its decision of
14 October 2002 by calling the advisor to the Governor, Mr L van
Zyl, to testify. He made the following points:(1)
The purported causality between turnover and the value of the
rand is not clear to the Reserve Bank at all. The Reserve Bank
82
83
Pages 23-24 of the DT Report referred to in Part K
Evidence of O’Neill, Record 1499 -1500
72
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
suggests that any causality is an over-simplification and that it
should not be accepted by the Commission.
One should look at different periods of rand weakness in an effort
to determine what causality, if any, may exist between either an
increase or decrease in turnover in the domestic rand forex
market and the exchange rate of the rand. For purposes of the
following examples, the Reserve Bank has used the total turnover
in the domestic rand foreign exchange market. Strictly speaking,
it would be more correct to focus on turnover in the spot plus
outright forward market as forex swaps do not directly affect the
spot exchange rate. This more correct methodology, however,
would not materially affect the Reserve Banks conclusion,
because the different components of turnover tend to move in the
same direction and by roughly the same magnitude. These are the
examples:(a)
In 1996 the rand depreciated from an average of USD1 =
R3.6410 in January to USD1 = R4.2057 in April, a
depreciation of 15.5%. Over the same period the average
daily turnover in the domestic rand forex market increased
by almost 42% from USD3.019 billion to USD4.284
billion. Total turnover by non-residents increased by some
79% from USD0.683 billion to USD1.223 billion.
73
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
(b)
In 1998 the rand depreciated sharply from USD1 =
R4.9357 in February to USD1 = R6.2386 in July, a
depreciation of 26.4%. Over the same period total average
daily turnover increased by some 139% from USD3.093
billion in February to USD7.395 billion in July. Turnover
with non-residents increased by 213% from USD1.323
billion in February to USD4.138 billion in July.
(c)
In January 1999 average daily turnover was USD6.855
billion. By June the average daily turnover had increased
by almost 33% to USD9.089 billion. Over the same period
the average daily exchange rate depreciated by a relatively
small percentage of 1.7% from USD1 = R5.9835 in
January to USD1 = R6.0883 in June.
(d)
The rand averaged USD1 = R11.5467 in December 2001,
fluctuating significantly and briefly depreciating to USD1
= R13.84, on an average daily turnover of USD6.051
billion. In February 2002 average daily turnover had
declined by 19.4% to USD4.876 billion, but the rand was
far more stable, trading at an average exchange rate of
USD1 = R11.4847.
(2)
The Reserve Bank suggests that had it not acted in October 2001
to limit dealing without a firm and ascertainable commitment or
74
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
approval in the domestic rand foreign exchange market, the
outcome in November and December 2001 might have been
much worse. Non-residents would probably not have bought the
rand when the currency fell on a surplus demand for foreign
exchange. It seems much more likely, based on past experience,
that had non-residents’ activities not been curtailed, they would
also have sold the rand when they perceived the currency to be
weak, leading to much more volatility and possibly a greater
depreciation. It should be borne in mind that by 14 October 2001
the rand had already started depreciating rapidly (see diagram 15
paragraph 3.1 hereof ).
(3)
In 2001 non-residents bought South African bonds and equities to
an amount of R4.203 billion. From the beginning of January to
the end of August 2001, net purchases of equities and bonds by
non-residents amounted to R11.914 billion. In the remaining four
months of 2001, this turned to net sales of R7.710 billion. The net
sales occurred from the very first business day of September
2001. Net sales of South African equities and bonds by nonresidents amounted to R5.510 billion. (Since the beginning of
2002 non-resident portfolio investments into South African
equities and bonds have again turned positive. From the
beginning of January 2002 to the end of April 2002 non-residents
75
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
have purchased South African equities and bonds to an amount of
R8.712 billion. This inflow has probably contributed to the rand’s
recent stronger performance, notwithstanding the fact that
turnover in the domestic rand forex market in March 2002 was
still lower than in the months prior to October 2001.)
The Reserve Bank submits that the statement of 14 October 2001, which
had been extensively discussed prior to its issue, was carefully
conceived and did not contribute to the rapid depreciation of the
exchange rate of the rand.84
16
The issue of Circular D346 on 13 November 2001
16.1
Institutional investors, eg pension funds, long-term insurers, unit
trusts and fund managers, may make off-shore investments up to
a specified portion of their total assets under management, which
is limited to a percentage of the inflow into the fund concerned
during the previous year. Institutional investors tended to take out
their allowances in tranches, beginning after the release of the
annual Exchange Control Circular, normally close to the budget
speech day, continuing through the second quarter of each year.
16.2
On 13 November 2001, Exchange Control issued Circular D346
which permitted an additional class of institutional investor,
84
Evidence of Van Zyl, Bundle SARB (9) 8-12
76
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
namely, fund managers, to invest a portion of their funds offshore. Following on that permission, applications totalling R1.9
billion were received in November 2001 and approved by
Exchange Control in December 2001. The approvals expired
within 30 days or at the latest 31 December 2001.
16.3
In order to utilise their allowances before expiry, the institutional
investors bought foreign currency to buy shares and/or placed the
foreign currency on deposit in anticipation of buying shares in
2002. SCMB Securities (Pty) Ltd obtained an extension to use its
allowance until 14 December 2002.
16.4
As a consequence, the foreign currency equivalent of R1.7 billion
was bought by institutional investors in an illiquid and volatile
market. The rand fell from R10.25 on 1 December 2001 to
R11.97 on 31 December 2001 and reached a low of R13.81 on 21
September 2001.85
(b)
Speculation
Introduction
17
The first point is that speculators have a necessary role to play in the
forex market. Dr Stals said that in a well developed market there is a
85
Evidence of Ms Beck referred to in Part J §8.3 below and in Record 1617
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need for short, medium and long-term investors and for buyers and
sellers of a variety of spot and forward instruments. The speculator has
an important part to play in an effective price discovery mechanism,
based on the principles of demand and supply operating in an
amorphous market.86 Mr Luüs testified that speculators are usually
required for the efficient functioning of markets. He quoted Marc
Levinson, who stated in his book, Guide to the Financial Markets:
“Although speculation is often derided as an unproductive activity, it is
essential to the smooth functioning of the market. By buying and selling
contracts with great frequency, speculators vastly increase liquidity, the supply
of money in the markets. Without the liquidity that speculators provide, the
futures market would be less attractive to hedgers because it would be more
difficult to buy and sell contracts at favourable prices.”87 Ms Ramos said in
her evidence that not all speculation is bad. Speculators can help in
making a healthy market. She added a word of caution by referring to
what John Maynard Keynes said in 1939 in his seminal work, The
General Theory of Employment, Interest and Money: “Speculators may
do no harm as bubbles on a steady stream of enterprise. But the position is
serious when enterprise becomes the bubble on a whirlpool of speculation.”
Ms Ramos added that it is a matter of balance: “Speculators can help make
a liquid market while there is a healthy demand for and supply of assets or
86
87
Stals, Expert Bundle 177
Luüs, Expert Bundle 214
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currency, and where the burden of the spread is tight. The deeper the more
liquid the market, the more likely it will be that speculators will be bubbles on
a steady stream. However, in thin markets or in one-sided markets, as was the
case in the rand market in November [2001] and particularly in December,
88
speculators will have a greater impact, even with very small transactions.”
18
The second point is that speculative activity is difficult to define. As
pointed out by the Governor, if speculation implies transactions entered
into based on a view of the future value of a currency, then most forex
transactions would have a speculative element in them. If speculation is
defined to include only transactions which are not based on some fixed
and ascertained commitment, then a narrower set of transactions would
be caught within the definition.89
19
Some of the authorised dealers in evidence canvassed the activity of
“speculating” in the rand. Nedcor’s evidence was that it did not regard
profits or losses generated or sustained by the bank from trading in the
rand to be unethical or improper in any way. In order to provide a
service as a market maker, it is important to be correctly positioned for
anticipated moves in the currency. This entails assuming risk. The bank
permits speculative risk taken on a conservative scale. “Speculative”
88
89
Ramos, Record 718
Mboweni, Bundle SARB (7) 38-39
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implies assuming a risk position with a view to making a profit, the
outcome of which is uncertain. This is not only applicable to currency
traders but involves exporters, importers, institutions and individuals.90
NIB testified that it did not believe that profit made from trading to be
unethical. The bank has to make profits. NIB would describe speculation
as betting on the future price of a defined asset. Speculation per se is not
an unethical practice simply because once a trader has made a bet there
is every chance that he or she could incur a loss. When there is a risk of
making a loss, the speculation cannot be improper. Market makers
essentially provide liquidity to a select client base. In order to facilitate
this practice market makers will enter into directional positions based
upon the assumptions of market needs via the supply and demand.
Speculators are defined as “market users” as opposed to “market
makers”.91 FirstRand defined speculation as the purchase or sale of
anything with the objective to profit from a change in market prices or to
avoid a loss due to such changes, usually with a short-term view.
Speculation by residents in foreign currency against the rand should
have had no net effect on currency reserves because the profit remains in
rand. It would seem that any large scale speculation against the rand,
other than transactions within the ambit of exchange control, would have
90
91
Evidence of Parker, Nedcor Bundle 18-19
Evidence of Lane, NIB Bundle 18
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to be undertaken by non-resident banks or through non-resident banks
and not by residents because of exchange control.92 Investec expressed
the opinion that a speculator can be defined as anyone who uses the
market to gain from a position with or without there being any other
underlying transaction. The decision to hedge or not to hedge an
underlying exposure is in itself speculative. Speculators provide the
liquidity necessary to ensure that whenever a hedger requires a hedge
position, the market is able to absorb his trade without undue
disturbance to the current price. Speculators are confined mainly to
professional traders.93 BoE testified that ordinarily the expression
“market maker” means any person who buys and sells in the relevant
financial market. Any trading in forex or related markets from an
unmatched position and directed at making a profit based on an
anticipated movement in the markets, necessarily involves an assessment
on the basis of available information of the direction of such movement.
By their nature, one cannot be certain whether any particular assessment
of future markets will be correct. In that sense, any such involvement
entails an element of speculation. All trading activity in a commodity,
whether it be a currency, a financial instrument or otherwise, where that
commodity is purchased for re-sale, is ordinarily undertaken with a view
92
93
Evidence of Bester, FirstRand Bundle 14-15
Evidence of De Villiers, Investec Bundle 34-35
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to re-sell at a profit and would not be undertaken if the assessment was
that the commodity could only be resold at a loss. There is therefore no
difference between “market-making” and “speculation” in the context of
forex and related markets. The word “speculation” is frequently used in
a pejorative sense to convey that particular trading activities are in some
way improper or unethical, but in that sense it has no clear or defined
meaning.94 It was JP Morgan’s submission that the concept of
“speculation” is not helpful in differentiating accurately between
different forms of commercial activity. All commercial activity,
including investment and risk management, involves an element of risk.
The assumption of risk necessarily connotes an element of uncertainty as
to whether a particular result will eventuate. Engrained in the notion of
uncertainty is a speculative view been taken by an investor or risk
management.95 SCMB does not regard profits made from proprietary
trading, market making, or other trading in the rand to be unethical or
improper in any way. Those activities are necessary economic activities.
If South African banks did not provide those services or activities, the
void would be filled by international banks operating in London and
other financial centres to the detriment of the South African economy.
94
95
Evidence of Woollam, BoE Bundle 5-6
Evidence of Coulter, JP Morgan Bundle 9
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SCMB, as a matter of policy, does not condone engaging in the
following types of conduct, which it regards as improper:
-
the execution of a large client deal in times of high volatility and low
liquidity and which the bank has reason to believe will have an
exaggerated effect on the exchange rate;
-
the practice of front running, which occurs when a bank or trader
makes a monetary gain by acting in advance of a known transaction
or order, which may influence the exchange rate; and
-
the exploitation of electronic dealing or broking systems generating
artificial exchange rate behaviour.
For SCMB, it is important to understand the distinction between
speculation and market making in the context of foreign exchange and
other related markets. Speculation involves adopting the view as to the
likely movements in the exchange rate and acting, or not acting, on that
view. By contrast, a market maker is a bank that, in all liquidity
conditions, commits itself to provide bid and offer prices to both the
inter-bank market and to its clients. Market making involves the
purchase and sale of foreign currency with the intention of making a
margin return, while not holding significant positions for extended
periods. By far the majority of SCMB’s foreign exchange business in the
rand is done on the basis of it being a market maker, in other words as a
provider of liquidity. The bank has historically, and for 2001, adopted a
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conservative approach to the size of its currency positions. It operates
well within the internal limits set by the SBCA board, which in turn are
significantly lower than those allowed by the Reserve Bank.96
20
In their replies to the questions put to them by Deloitte & Touche,97
most authorised dealers stated that speculation is often used in a
pejorative sense, implying that speculative activities are in some way
improper or unethical. This they said is unjustified and choose rather to
define speculation as adopting a view as to the likely movement in the
exchange rate of the currency and acting on that view with the intent of
making a profit or preventing a loss. They believe that speculation in
fact has a positive effect on the markets as a result of the liquidity that
speculators bring to the market. All agreed that according to their
definition of speculation they do engage in speculation but that this is in
no way unethical, improper or illegal. The consensus among the material
authorised dealers was that profiting from proprietary trading and market
making was in no way unethical or improper. They asserted that these
activities are necessary economic activities that are conducive to a
dynamic, liquid and efficient financial market.
96
97
Evidence of Potgieter, Standard Bank Bundle 45-47
See Part K for the role played by Deloitte & Touche in the investigation on behalf of the
Commission. §20 is based on p 22 of the DT report.
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21
Mr McCauley drew a distinction between “hedgers” and what he called
“pure short sellers” or “naked shorts”. The former class of person would
include a multinational company that has a long position in South
Africa: it has bought dollars and invested the dollars in a factory in
South Africa. If it becomes concerned about the value of the rand, it
would hedge that long position by selling the rand forward against the
dollar.98 A “pure short seller” or “naked short”, by contrast, is an
institution such as an investment fund that has no ongoing business in
South Africa and which “could put on the short basically looking to
profit if the rand goes down”.99
22
Mr De Villiers defined speculation as any transaction in which a trader
acts as principal. Market-making can be viewed as speculation because
the market-maker trades as principal and has to provide a price for a
currency to a counter party. The price will be speculative in nature
because “you will move it up and down according to what you perceive that
the counter party is going to do with you.”100 Day-to-day speculation in the
form of market making and technical trading is a necessary function for
any market. It helps a market to be efficient and obviously helps people
who needs hedges to hedge properly and cheaply. Speculation which has
98
99
100
McCauley Record 28
McCauley Record 29
De Villiers Record 367-8
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a negative connotation probably refers “… to the long directional trading
where traders take the long-term position of shorting the rand against the
dollar and they do it for large amounts.”101
23
The third point is one made by Dr Abedian. He testified that financial
markets are neither efficient nor socially optimal. They are structurally
prone to short-lived as well as prolonged “bubbles” in which prices and
quantities could deviate from private and socially optimal levels.
Information plays a vital role in such markets. As such, financial
markets are largely vulnerable to information manipulation, rumours and
speculation. Given costly and imperfect information, a large number of
players in these markets may adopt a “herd mentality”, following bigger
players who can afford the investment in information gathering or will
have the critical mass to obtain information. Institutional arrangements
for remuneration are commonly and justifiably “performanceorientated”. Despite a variety of checks and balances in the financial
markets, such remuneration frameworks tend to exacerbate the
vulnerability of these markets to short term bubbles.102
24
The fourth point that a number of witnesses made was that it would be
extremely difficult to determine the effect of speculative transactions on
101
102
De Villiers Record 376
Abedian Expert Bundle §2.8 p 261
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the exchange rate.103 A total of approximately 5.6 million foreign
exchange transactions were reported to Exchange Control in 2001.104 Mr
Gouws expressed the view that to attribute the fall in the rand to a
number of specific transactions would be very difficult and perhaps
pointless in the light of the magnitude and complexity of developments
since early September 2001.105 Dr Stals made a similar point. He said
that in a market with a turnover of at times more than USD10 billion per
day, it would be extremely difficult to discover and identify individual
transactions with malicious intentions.106
25
It seems to the Commission that one should distinguish between two
classes of transactions, as identified by the Governor:-
transactions entered into based on a view of the future value of a
currency; and
-
transactions which are not based on some fixed and ascertained
commitment.
In the former class of transactions, would fall the transactions of
authorised dealers, non-residents and resident importers and exporters.
103
104
105
106
Mboweni Bundle SARB (7) 38
Bruce-Brand Bundle SARB (9) 5
Gouws Expert Bundle 117
Stals Expert Bundle 177
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25.1
Authorised dealers
South African authorised dealers are allowed to trade the rand for
their own account in the inter-bank market. This form of forex
trading is known as “proprietary trading”. During 2001 the
authorised dealers did not run huge positions against the rand.
Their aggregate open positions amounted to less than 1% of their
net qualifying capital in 2001. The statutory limit for those
positions is 10% of net qualifying capital.107
An authorised dealer, being a market maker, can be given a
position by virtue of a deal being struck. The position which he is
left with holding and which could be sizeable, may take some
time to unwind and can even be rolled in to the forward market.
Decision-making in this regard will be influenced by regulatory
limits, internal limits and the view on the rand.108
25.2
Non-residents
The Governor expressed the view that, owing to the relatively
free access that non-residents, particularly banks, enjoy in the US
dollar/rand forex market, non-residents are in a position to
speculate on the rand. South Africa has the mixed blessing of
107
108
Mboweni Bundle SARB (7) 39
Memorandum of Reserve Bank Bundle SARB (7) 104
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having more liquid financial markets than most other emerging
markets. Consequently, in times of international crisis, South
Africa’s financial markets could be used as a proxy hedge for
exposures to other emerging-market countries. Some of the nonresidents view the rand as an international hedge currency and,
through their established emerging markets trading desks, are
prepared to trade the rand on a proprietary basis, that is for their
own account. Non-resident banks trade rand very actively and
represent some 55% of the total turnover in the rand forex market.
It is because of the belief that non-residents were trading contrary
to the existing exchange control rules (ie there was no underlying
commitment to the transactions) that the statement of 14 October
2001 was issued.109
25.3
Importers and Exporters / Leads and lags
25.3.1 To enable the main bankers of major corporates to cope
with the flow of foreign currencies, a system was devised
whereby the funds were administered by the banks as part
of their nostro110 or vostro account balance pending
conversion. To assist in identifying those funds separate
sub accounts in the name of the customer were opened in
109
110
bank.
Mboweni, Bundle SARB (7) 40-42; McCauley, Expert Bundle 58
A nostro or vostro account is the foreign currency account of a local bank with an overseas
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the bank’s nostro accounts (shadow) administration. Those
accounts are known as the Customer Foreign Currency
(CFC) accounts. In March 1998 the exchange control
requirement to repatriate foreign currency earnings in
respect of the export of goods and services within 30 days
was extended 180 days from date of shipment or date of
service rendered. In September 1998 the CFC account
system was amended to allow the retention of foreign
currency earnings in respect of the export of goods for 180
days from the date on which such funds were first credited
to the CFC account.111
25.3.2 An exporter who anticipates a more favourable exchange
rate delays converting export proceeds in the foreign
currency (eg US dollars) into the domestic currency (eg
rands) (“lags” its payment.) An importer who fears a worse
exchange rate can accelerate payments for imports by
buying the foreign currency forward (“leads”).
25.3.3 According to the Reserve Bank, in the second quarter of
2001, the total exports of goods and services from South
Africa, at a seasonally adjusted annualised rate, amounted
to some R328 billion, with imports of goods and services
111
Bruce-Brand Bundle SARB (6) 19-20
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amounting to almost the same. Even if a small portion of
those amounts was involved in leads and lags, it could
have had a noticeable effect on the exchange rate.
Importers and exporters are thus in a position where they
can legitimately take sizeable positions by virtue of their
views on the rand’s prospects. They have the same impact
on the rand as pure speculative activity.112
25.3.4 The Reserve Bank draws the inference that exporters were
lagging the repatriation of foreign currency (albeit possibly
within the 180 day period) from the fact that there was a
gradual increase in the forex balances of South African
corporates in their CFC accounts as at:
31 December 1998
USD995m
31 December 2000
USD1 981m
31 December 2001
USD2 625m.113
25.3.5 Mr McCauley expressed the opinion that while it may not
on the face of it appear to be so, a type of portfolio shift
occurs in the financing of imports and exports (leads and
lags): every month of lead in payment and lag in receipts
112
113
Mboweni Bundle SARB (7) 39-40
Mboweni Bundle SARB (7) 40
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represents an outflow of 1/12 of trade. The leads and lags
phenomenon makes the distinction between goods and
financial services seem artificial in practice.114
25.3.6 Dr Abedian expressed the view in his evidence that while
there might have been good technical reasons for
extending the period of repatriation from 30 days to 180
days, exporters no doubt find it profitable to retain their
earnings for as long as possible. With the continuous
weakening of the currency in recent years, it has become
common knowledge that any delay in repatriation is likely
to make currency gains over and above the trade profit. It
is important to note that had it not been for the predictable
one-way direction of the currency value, exporters would
normally choose to “take cover” for their CFC holdings so
as to hedge against any potential appreciation of the rand.
Expenses involved in such hedging would have forced
them to retain their hard currency deposits only on an asneeded-basis and no longer. However, in view of the
downward trend of the value of the rand, CFC accounts
have become profitable operations for exporters and they
114
McCauley Record 48, Expert bundle 49
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have every reason to accumulate deposits in such
accounts.115
25.3.7 The probability that importers would hedge their purchases
of foreign currency (lead) and exporters would delay
repatriating their rands from off-shore (lags) is supported
by the analysis done by Mr Glynos in this table:
Table 1 Expert Bundle 453
Forward points on the ZAR relative to the spot rate
Table 1
Forward points as of 01/01/2000 (Bid)
3 month forward points
6 month forward points
12 month forward points
Column 1
Column 2
Column 3
Column 4
Spot rate on
01/01/2000
Forward rate as
of 01/03/2000
Forward rate as
of 01/06/2000
Forward rate as
of 01/12/2000
6.1425
795
1480
2850
Actual spot rate on respective dates
6.2905
6.4275
6.34
6.975
Difference
0.1180
0.6845
1.1900
% terms
1.90%
9.80%
15.60%
Spot rate on
01/01/2001
Forward points as of 01/01/2001 (Bid)
3 month forward points
6 month forward points
12 month forward points
7.5625
790
1480
3280
Actual spot rate on respective dates
Forward rate as
of 01/03/2001
Forward rate as
of 01/06/2001
7.6175
Forward rate as
of 01/12/2001
7.6415
7.7105
7.8905
7.715
8.0225
Difference
0.7350
0.3100
2.3645
% terms
0.90%
3.90%
23.10%
Spot rate on
01/06/2001
Forward points as of 01/06/2001 (Bid)
3 month forward points
6 month forward points
12 month forward points
115
6.222
8.0225
1370
2680
5090
Forward rate as
of 01/09/2001
Forward rate as
of 01/03/2002
8.1595
8.2905
Actual spot rate on respective dates
8.4526
11.38
Difference
0.2931
3.0895
% terms
3.50%
27.10%
Abedian Expert Bundle 269
10.255
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In each case the actual spot rate on the forward date was higher
than the forward rate. Take, for example, the twelve month
forward points:
For the year 2000:
Actual spot
Spot rate on
Forward rate
rate on
Percentage
01/01/2000
on 01/12/2000
01/12/2000
Difference
6.1425
6.4275
7.6175
15.60%
For the year 2001:
Actual spot
26
Spot rate on
Forward rate
rate on
Percentage
01/01/2001
on 01/12/2001
01/12/2001
Difference
7.5625
7.8095
10.255
23.10%116
Another fairly common way of speculating involves “short-selling”.
This amounts to a market participant selling a currency which he does
not own, in anticipation that when delivery needs to take place, the
currency can be bought in the market at a lower price, basing his
116
Glynos Expert Bundle 453
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judgment on the expected future development of the price of the
currency.117
27
Another type of speculator is the offshore investor who has bought
South African Government bonds and wishes to hedge his currency
exposure and so sells rand forward.118
28
28.1
Dr Jammine is of the view that the leads and lags phenomenon
was exacerbated by panic by importers and glee by exporters who
deliberately held off repatriating dollars for as long as possible.
He sees in an asymmetric trend for a protracted period of time in
which the demand for dollars by importers is abnormally low
while at the same time the supply of dollars by exporters is
abnormally low. That is why the rand has tended to overshoot and
then recover in its downward slump during sell offs such as those
seen in 1985, 1986, 1996, 1998 and 2001:
117
118
Memorandum of Reserve Bank Bundle SARB (7) 104
Memorandum of Reserve Bank Bundle SARB (7) 104
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Chart 58 Expert Bundle 420
REAL EFFECTIVE EXCHANGE RATE
140
Recoveries after
sharp falls
BASE 1995=100
120
1996
1986
100
80
1998
1985
60
40
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02
Chart 58
28.2
In November, and particularly, December 2001 the rand,
according to Dr Jammine, entered a “blow-off” phase. The entire
depreciation of the rand against the dollar from the beginning of
2000 until September 2001 saw the depreciation of the rand
occurring within a clearly defined upward channel. However,
once the dollar had broken the upward channel on the upside, it
was apparent that the currency was in unchartered territory and
would keep running upwards in an ever dramatic fashion against
the dollar until the movement blew itself out. The channel
referred to by Jammine is shown in the following chart:
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Chart 59 Expert Bundle 421
EXCHANGE RATE RAND / US DOLLAR
14.0
Classic Blow-off
RATE
12.0
10.0
8.0
6.0
2000
Chart 59
28.3
2001
11 Sept2002
Dr Jammine stated that even though the depreciation of the rand
until about October 2001 could be justified somehow on
economic and political grounds, the move in November and
especially December 2001 defied the bounds of normal economic
and political analysis and logic. He suggested that some people
must have profited enormously at the time and that those
speculators were found in the financial services industry both
domestically and abroad.119
29
Dr Abedian’s evidence was that there were “pure currency speculators”
in the rand to an estimated volume of USD200 million to USD300
119
Jammine Expert Bundle 343-345; Abedian, Expert Bundle 260-261
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million per day. He said: “I highlight here that there is no way by definition
to quantify it, but my discussion with the trade both inside and outside the
country is that this volume had grown by September last year to an estimated
or guestimated amount of possibly as high as 300 million dollars per day.”120
[3]
The experts’ conclusions121
(1)
Mr Gouws
30
Mr Gouws came to the conclusion that against the background of a
steady depreciation of the rand during 2000 and the first half of 2001
most market participants came to the view that the currency was weak
and it is likely that they took decisions to help protect themselves against
further weakness. There was, therefore, already a weakening bias in the
currency by the time the extraordinary confluence of factors and forces
started to exert an influence from early September 2001 onwards. Some
of those affected the currency via the influence on the current account;
most affected the currency via the negative impact on confidence and on
expectations about capital flows. The role of these factors became
magnified after mid October 2001 by a lower level of market liquidity
120
121
Abedian Record 422
The evidence of the experts is dealt with in the order in which they gave evidence.
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following the Reserve Bank’s announcement that foreign exchange
control rulings were to be policed more rigorously. Some market
participants may have taken advantage of the prevailing circumstances,
but the sharp decline of the currency was the result of economic,
political, policy and confidence factors and forces that had built up over
a number of months. To attribute the fall in the rand to a number of
specific transactions would be difficult and perhaps pointless in the light
of the magnitude and complexity of developments since early September
2001.122
(2)
Dr Stals
31
Dr Stals summed up his views as follows:(1)
The South African exchange rate is determined by forces of
demand and supply. The system of a managed float is by its
nature unstable. Volatile movements in the exchange rate can be
expected from time to time.
(2)
The nominal exchange rate of the rand against other currencies
will over time depreciate more or less by the inflation differential
between South Africa and its major trading partners.
122
Gouws Expert Bundle 117
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(3)
Globalisation led to an integration of financial markets on a
worldwide basis. There has been a big increase in international
capital flows. Turnovers in foreign currency markets assumed
astronomical dimensions. South Africa participated in those
developments and removed or relaxed exchange controls to an
important extent. All those developments contributed to a more
volatile exchange rate for the rand.
(4)
In the second half of 2001 various adverse external and domestic
developments led to a deterioration in the South African balance
of payments and therefore to a decline in the supply of foreign
exchange.
(5)
Without any official support, shortages developed in the market
for foreign exchange with a strong concurrent pressure on the
rand to depreciate.
(6)
There was a growing perception in the market that the rand would
continue to depreciate. Protective action by importers and
expedient conduct by exporters squeezed the market even further.
In December 2001 there were signs of panic in the market
because of the shortage of liquidity.
(7)
The reduction in the NOFP may have contributed to the woes of
the rand. The role of the NOFP in the depreciation of the rand
has, however, been exaggerated in the media and in the market.
100
Commission of Inquiry into the rapid depreciation of the exchange rate
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As long as the Reserve Bank enters into forward foreign
exchange cover transactions for South African residents in respect
of “firm, ascertained and documented” commitments, increased
or declines in the NOFP will be neutral as far as supply and
demand conditions are concerned in both the markets for foreign
exchange and for domestic rand liquidity.123
(3)
Dr Abedian
32
Dr Abedian summed up the “bottom line impact” of the factors analysed
in his report and evidence as follows:
(1)
Net demand for the rand had diminished substantially.
(2)
Policy uncertainty and an implicit policy re-think influenced the
market.
(3)
A one-way bet on the currency had taken root.
(4)
No obvious defence for the currency was evident.
(5)
Liquidity in the market was diminishing from mid-year on and
reached low levels during the fourth quarter of the year.
(6)
Global and environmental factors continued to weigh adversely
on the currency.
(7)
123
The market conditions were ripe for a run on the currency.
Stals Expert Bundle 183
101
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Dr Abedian identified three possible scenarios for the rapid depreciation
of the rand in December 2001:(1)
A perfectly legitimate large transaction by one of the major
market players might have led to the emergence of a herd
mentality resulting in the run on the rand.
(2)
It is technically possible that one may execute a deal fully aware
of the full-scale domino effects and one does so in order to
benefit via a major deal already in contract. Such a situation was
particularly more feasible when the pure speculators were driven
out of the market by November 2001.
(3)
There were uncoordinated numerous market transactions that
culminated in a self-fulfilling prophecy leading to a severe
overshooting in valuation of the currency. Deals of this kind
might well have had no motive other than well-considered
business logic, yet the impact or outcome was identical to either
of scenarios 1 and 2.124
(4)
Mr Bruce-Brand
33
Mr Bruce-Brand testified that he was not able to isolate any transactions
which caused, contributed and/or gave rise to the rapid depreciation of
the value of the rand. Furthermore the numerous economic and political
124
Abedian Expert Bundle 282, 283
102
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
factors mentioned by the various witnesses influenced the exchange rate
of the rand – which would make the task even more difficult for him.125
(5)
Mr Mboweni
34
34.1
The conclusion that Mr Mboweni, the Governor, came to was that
the exchange rate obviously came under a great deal of pressure
in the latter half of 2001. If developments in the balance of
payments are taken into account, as well as the other issues
mentioned by him, including the fact that market participants
would tend to trade according to the view that the rand was
vulnerable, thereby adding further pressure to the rand, the
depreciation in the value of the rand was not altogether
unexpected. Admittedly the severity and the speed of the decline
were surprising and of great concern.
34.2
It is the view of the Reserve Bank that the best defence of a
currency is prudent macro-economic policies accompanied by
structural and micro-economic reforms, where appropriate.
34.3
The Governor defended the Reserve Bank’s role in 2001 by
stating:
125
Bundle SARB (6) 24
103
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
-
given the inflation targeting monetary policy framework
under which the Reserve Bank operates, it was not
considered appropriate to hike interest rates in defence of
the currency;
-
it was not considered appropriate to intervene in the forex
market to support the value of the rand by means of the
forward book;
-
on 14 October 2001 it was felt appropriate to enforce
existing exchange controls on non-residents to ensure that
only legitimate transactions took place in the forex market;
-
contained in the statement of 14 October 2001 was a very
positive announcement regarding future purchases of
foreign exchange to reduce the NOFP;
-
in a joint statement issued by the Governor and the
Minister of Finance on 21 December 2001 the positive
economic fundamentals were reiterated.126
126
Mboweni Bundle SARB (7) 46
104
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
(6)
Ms Ramos
35
35.1
Ms Ramos said that the Government has had to make policy
choices in a complex and often unforgiving world. At the centre
of the range of policy choices lies the principle that South Africa
is an open economy. In that environment it is inevitable that from
time to time there will be turbulence. The policy makers must be
confident that the policy choices they have made and the good
performance experience for the economy of the past five or six
years will support the ongoing growth and sustainable
development that the South African economy needs.
35.2
The Government has had to ensure that the appropriate macroeconomic fundamentals are in place. Far-reaching reforms of the
fiscal framework and management of public finances have been
undertaken. Monetary policy has been consistent in tackling the
distortionary impact of high inflation. Trade reform and financial
market development have increased the flow of foreign currency
to South Africa. Government’s spending has been re-prioritised to
increase spending on social services, which promotes redistribution and provides a safety net against the potential social
105
106
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
costs of globalisation.
35.3
In an environment of global integration, it is essential for a sound
and well regulated financial system to be in place. Government
has achieved this through an ongoing financial market reform
aimed at keeping South African financial market standards
consistent with international practice.
35.4
Government has chosen to follow a flexible exchange rate to act
as a shock absorber against global developments. Exchange rate
adjustments helped cushion the economy from external trade and
capital flow shocks, and mitigate the impact of economic
contraction, especially in respect of the poor.127
35.5
There was no single or dominant cause for the depreciation of the
rand. Ms Ramos said: “There were a number of variables at play at
the same time and certainly in our attempts to try and understand what
was going on, we have been unable to say what caused it was A and
not B. It was a complex set of issues not least of which is the
confidence that South Africans have in their own country and their own
economy and so it has been difficult for us to say that there was one set
of issues that led to the exchange rate depreciation that we saw last
year. There were lots of things happening at the same time.”
128
The Minister of Finance spoke of a complex set of factors which
127
128
Ramos, National Treasury Bundle, 58-59
Ms Ramos Record 735-6
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
were at play. 129
(7)
Dr O’Neill
36
In mid-April 2002, Goldman Sachs asked thirty clients four questions.
Twenty-nine clients replied. The clients were multi-currency asset
managers in London and New York, hedge funds, corporations with
commercial exposure in South Africa and one or two individuals. The
group is representative of the global financial community. The questions
and answers were:
Question
Answer
1.
31% bullish
Are you bullish/bearish about rand
69% bearish
2.
Do you think the monetary and fiscal 59% good
policy is good or bad?
3.
Do
you
think
the
41% bad
framework
has 52% improved
improved/deteriorated in the past year?
4.
48% deteriorated
What is the biggest change that would be [A]
positive for the rand?
(i.e.
More open markets
remove
exchange
controls): 21%
[B]
129
Manuel Bundle National Treasury 87
Open more FDI:
107
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
14%
[C]
Zimbabwe: 21%
[D]
Aids: 14%
[E]
Crime: 10%
[F]
NOFP/other:
21%130
37
Dr O’Neill came to the following conclusions:(1)
The foreign exchange markets have been generally very peculiar
since 1999 since the introduction of EMU. Lots of currencies,
including the most important in the world, the dollar, and the euro
specifically, have behaved very differently than the consensus
expected.
(2)
The US dollar has been and remains peculiarly strong because of
lots of capital inflows including foreign direct investments and
portfolios [into the USA].
(3)
Until late 2001 the rand was not independently weak from the
general weakness which other currencies showed against the
dollar.
(4)
Policy should concentrate on inflation targeting and not on the
rand. If policy was supplemented and intensified with its inflation
130
Evidence of O’Neill, O’Neill Bundle 33, Record 1500-1502
108
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
targeting, some of the problems surrounding the rand would
probably go away.
(5)
If South Africa wants a strong rand, South Africa needs to have a
BBoP surplus so that it will not be subject to the vagaries of
sentiment. The way to achieve that is to attract more foreign
direct investments and more portfolio flows.
(6)
The events of late 2001 suggest that with foreign exchange
controls, one either has no controls or one has complete controls.
But, if one has partial controls, it is confusing and very hard for
people to understand except those very close to monitoring them
and implementing them. It is also often taken as a sign of lack of
confidence in other targets and in particular if there is an inflation
targeting regime in place. It was not obvious to Dr O’Neill what
purpose foreign exchange controls serve. In his view, if the
removal of exchange controls was done in the context of
specifically targeting more foreign direct investments and
enhancing a greater broadening of the understanding of the
inflation targeting regime, he believes that the abolition of
exchange controls will lead to a significant inflow and
strengthening of the rand.131
131
Evidence of O’Neill, O’Neill Bundle 34, Record 1503-1504
109
110
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
(8)
Standard Corporate and Merchant Bank (“SCMB”)
38
The exchange rate of the rand is determined primarily by the actual and
expected level of net demand, which is demand for the currency minus
the supply of it.
39
In the view of SCMB, the following factors may have negatively
influenced the exchange rate for the rand during 2001:
-
the global economy was on a path of gradual slow-down with a
possible recessionary outcome even before 11 September 2001;
-
the
downturn
of
the
global
equity
market
in
the
telecommunication and aviation sectors contributed to a delay in
the Telkom and SAA privatisation plans thereby reducing the
prospects for the inflow of foreign currency;
-
negative developments in emerging economies such as Turkey
and Argentina;
-
the possible use by exporters of the full extent of the 180 day
period causing additional leads and lags in the foreign exchange
market;
Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
-
the reinforcement of the rules pertaining to non-resident dealings
by the Reserve Bank in October 2001 may have had the effect of
further draining liquidity in an already thin market;
-
the Reserve Bank’s non-interventionist approach appears to have
influenced perceptions in the market of a continued decline in the
value of the rand;
-
political and economical turmoil in neighbouring Zimbabwe;
-
the reduction of the NOFP;
-
Press comment on the outflow of dividends from South African
companies listed off-shore.
40
Participants in the forex market saw the rand hitting all-time lows
virtually every day and a certain amount of panic prevailed as relatively
small amounts of import demand influenced the exchange rate. Interbank spreads between buying and selling rates were quoted as high as
1000 basis points (normally 100 basis points). These conditions had not
previously been experienced in the South African market as the Reserve
Bank would, under such conditions and in terms of their then existing
policies have provided the necessary liquidity.132
132
Evidence of Mr WJ Potgieter, Director and Head, International Banking Division, SCMB,
a division of Standard Bank of South Africa Limited (“SBSA”), Standard Bank Bundle
47-49
111
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The views of the authorised dealers
41
In the Questionnaire, the authorised dealers were requested by the DT
team to describe inter alia the specific transactions, actions, events,
factors or omissions influencing the rapid depreciation of the rand in
2001. Their responses are summarised in the following table:
Table 4, DT Report p 40133: Details underlying reasons shown in figure 11
Cause
Zimbabwe
Details provided
Land invasions in Zimbabwe, lack of South African government
criticism of Zimbabwe, fear of Zimbabwe style land invasions in
South Africa, fear of influx of refugees from Zimbabwe, indications
that Zimbabwe's upcoming presidential election was unlikely to be
fairly contested.
Emerging markets/ Poor emerging market sentiment, emerging market contagion,
Argentina
economic problems in Argentina, specific events in Argentina (e.g.
resignation of president).
September 11
The events of September 11, terrorist attacks in the US, war on
terror, flight to quality post September 11.
Privatisation
Speculation regarding delays in privatisation, actual delays in
privatisation
trade deficit
Balance of payments concerns
SARB policies
Circular D342, comments by Reserve bank staff (including
Governor), closing out of NOFP, resignation of James Cross, use of
133
Pages 40-41 of the DT report referred to in Part K.
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Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
Table 4, DT Report p 40133: Details underlying reasons shown in figure 11
Cause
Details provided
De Beers inflows to offset against NOFP, speculation regarding
relaxation of exchange controls, statements regarding defence of the
currency.
Withdrawal of
Illiquid market, market makers withdrawing at times of high
market makers/
volatility, foreigners withdrawing, clamp down by SARB on
liquidity
speculation causing lack of liquidity.
leads and lags/
Use/abuse of 180-day rule, exporters delaying foreign exchange
investor panic
repatriations, panic setting in exacerbating Rand collapse.
Dividend
Offshore listed companies repatriating dividends to overseas
repatriations
shareholders in foreign currency.
Political factors
Negative view of South African Government performance,
government's Aids policy, government corruption, poor performance
of President Mbeki.
General market
Generally poor market sentiment.
sentiment
The views of the representative offices
42
The common factor influencing the rapid depreciation of the rand
amongst the representative offices was the political and economic
instability in Zimbabwe. Other top ranking factors included the listing
abroad of large South African corporations and the continued dividend
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Commission of Inquiry into the rapid depreciation of the exchange rate
of the rand and related matters: Final Report dated 30 June 2001
flows from South Africa which did not inject foreign currency into
South Africa in exchange for the dividend flows. The disaster of 11
September 2001 was listed as an influencing factor. It was felt that this
led to volatility in global equity and currency markets. Exchange control
regulations were also considered to have contributed to the depreciation
of the rand.134
134
P50 of the DT report referred to in Part K.
114